To The Moon

Investment Thesis

Most Chinese stocks are down since 2021 started, and Alibaba Group Holding Limited (NYSE:BABA) is not an exception to the rule.

Although many investors believe that the fundamentals are the same andthis drop in the stock price might have created a mismatch between the price of the stock and the value of the business and, therefore, an investment opportunity, this is not necessarily the case. The numbers have also changed since then.

The Business Has Changed

Alibaba of today is not the same as Alibaba of three to four years ago, as fundamentals have changed drastically. Three to four years ago, most of Alibaba's business was customer management. This comes with high margins, as the company had its own platform and provided services like marketing which does not cost much, but now Alibaba is diversifying its business.

Diversification

Alibaba has a stronghold in major cities. In fact, the corporation has a high revenue per user and a market share of almost 50%. The issue is that they must expand into rural areas in order to have additional user development because they have already monopolized the majority of metro areas. However, the company must provide something more necessary, like groceries, in order to expand there, because few people in rural areas need smartphones or other software services that the company provides.

Alibaba is buying grocery-related businesses for this reason. Therefore, as Alibaba continues to enter the grocery industry, overall profit margins will continue to fall as the grocery business has single-digit margins, and the fact that the company is spending billions of dollars in acquisitions to gain market share in this market indicates that the real growth is now in the rural area.

Revenue And Margins

Although Alibaba had great top-line revenue growth in the past, themarginsfell and are still shrinking.

As shown above, both gross and operating margins keep getting worse every year. The reason that this happens is that although the revenue grew by 23% YoY, the cost of revenue increased by 33%, and that is mainly because of the grocery and other unprofitable businesses that operate inside Alibaba.

So, although the overall business is growing, it also comes with less and less profitability. This happens because the only profitable business that Alibaba has (customer management) currently only contributes about 40% of the company's revenue, and the other 60% is other segments like cloud and logistics. Although they are growing at a high pace, they are not profitable yet, and that is why the operating margins keep declining.

Alibaba Is Becoming Capital Intensive

Generally, tech companies are asset-light businesses. They do not have high capital expenditures, as they don't have to purchase new factories or assets in order to expand. In the case of Alibaba, however,capital expendituresincreased even at a higher pace than revenue. This indicates that now Alibaba is becoming an asset-heavy business, and I think that this trend is not going to stop. In the future, Alibaba is projected to increase its revenue by double digits initially and then single, but this will probably also come with even lower margins than today.

Competition And Market Share

Although Alibaba still has a decentmarket shareof almost 50%, four years ago thisused to beclose to 60%, and it keeps decreasing every year.

This indicates that the company faces a lot of competition from companies like Pinduoduo (PDD) andJD.com (JD). This leads to the company spending constantly more money on marketing in order to gain back market share, which leads to lower margins, at least in the short term.

Pinduoduo Enters The US Market

Pinduoduo isgrowing fasterthan Alibaba in a rapidly growing market, as it is starting from a smaller scale but it is still trying to expand internationally.

Pinduoduo was already growing in the domestic retail Chinese market, so if the Chinese market is so strong, why would not the company try to dominate this market first and then try to expand?

Gaining market share is quite expensive when a firm enters the global market, particularly the U.S. market. At the very least, the company will lose money over the first few months, if not years. This occurs because the company must first acquire customers (customer acquisition cost) and will likely offer discounts and coupons to attract them in, which will result in a further loss of money. Next, the company must buy distribution centers, warehouses, logistics, and a new team (more people must be hired), and set up everything from scratch. However, Pinduoduo made the decision to concentrate on foreign growth rather than the domestic market, where there is considerably further space for growth.

This should surely make investors reconsider if the Chinese market is indeed as strong as it is said to be, because if it is not, Chinese companies like Alibaba and Pinduoduo will have a hard time growing 10%-15% by just operating in China and will have to expand internationally, going through a phase of reinvestments and, therefore, low margins.

Valuation

However, even though buying this company comes with a lot of risks, some investors support that they are all already priced in the stock and that is a rational argument.

Alibaba'svaluation gradeis C- according to SeekingAlpha.

The company is trading at a P/S ratio of 1.64, which is quite low for a company that still monopolizes a huge market and is stillexpected to grow its revenueby 7%-13% for the next five years. Moreover, its P/FCF is less than 10, which is not only almost half the company's 5-year average P/FCF but is also 30% less than the sector's median, although the company keeps reinvesting money back in itself. These metrics indicate that although this is a risky investment, the stock is currently trading at a discount and therefore could still beat the market.

Conclusion

To sum up, Alibaba was a company that I had a hard time analyzing. On the one hand, its business model is currently unstable and there are many risks that come with buying the stock. But, on the other hand, I cannot turn a blind eye to the cheap valuation. I would not buy the stock at the moment, but I also wouldn't sell it if I already had it in my portfolio. I think that the best strategy right now is to wait for the smoke to clear and then judge. For now, Alibaba seems to be a high-risk high-reward investment.

I am currently neither bullish nor bearish at the stock, and, therefore, I rate Alibaba Group Holding Limited as a HOLD.