Alibaba Group Holding Ltd (BABA, Financial) is the largest e-commerce company in China. Over the past decade, the company has benefited from the astronomical growth in China’s GDP and the rapid adoption of e-commerce. It's also expanded into various other growth avenues, including Cloud services.
However, the company has also faced a series of major challenges. To provide a brief summary, the company's founder Jack Ma made a controversial speech that criticized the entire Chinese financial system, which served as the trigger for the Chinese government to begin a regulatory crackdown on tech monopolies including Alibaba. A subsidiary of Alibaba, Ant Group, even had its ~$35 billion IPO halted. As if that wasn't bad enough, the U.S. government passed a bill mandating that non-U.S. stocks be delisted from U.S. exchanges if the companies didn't submit to audits from U.S. regulators. This has all been happening against a tough economic backdrop, Covid lockdowns and slowing revenue growth.
Split creates a new opportunity
Even as the above-mentioned issues have slowly been resolved over the years, Alibaba's stock has yet to recover. The good news for Alibaba is the tide may be about to turn as the company has recently announced plans to split into six separate business segments, each of which will have its own IPO. This is expected to have a number of benefits, from faster and more agile decision-making to easier accounting and shareholder value creation.
In addition, each business will be able to raise external capital to grow and will likely entice the "right kind of investors" into investing as the segments will be easier to understand on their own. For example, those investors who want e-commerce exposure will be able to invest directly in the “China Commerce” segment which includes Tmall, Taobao, etc., while those investors who believe in the huge potential of the Cloud segment might prefer to invest only in the Cloud Intelligence Group.
The segments will be broken down as follows:
- The China Commerce (Taobao and Tmall) Group - Core e-commerce business.
- The Local Services Group - Alibaba’s food delivery service Ele.me and mapping. Yu Yongfu will lead as the CEO.
- The Cloud Intelligence Group - Alibaba Cloud and artificial intelligence. Current CEO Daniel Zhang will take over.
- Cainiao Smart Logistics - Alibaba’s logistics service. Wan Lin will remain as the CEO.
- The Global Digital Commerce Group - International e-commerce (exports), to be headed up by Jiang Fan as CEO.
- The Digital Media and Entertainment Group - Alibaba’s movies and streaming business. Fan Luyuan will be the CEO.
Given Alibaba reported just 1% revenue growth for the third quarter of fiscal 2023, this break-up is needed to re-focus investors' attention and bring in more investment dollars. It should also help keep regulators' attention off the company, which is important.
Breaking revenue down by segment, the China Commerce segment is the largest and contributed ~69% of revenue in the third quarter of fiscal 2023, though this declined by 1% year over year. This was mainly driven by the Covid lockdowns. A positive is these lockdowns now look to be easing as health officials reported the recategorization of Covid-19 to a safer classification in the same box as the regular flu.
Its segment biggest segment, Alibaba Cloud, contributed ~8% of revenue and grew by just 3% year over year. This was a surprise to me, given McKinsey forecasts China’s Cloud industry to nearly triple from $32 billion in 2021 to $90 billion by 2025. Therefore, I suspect the company is facing headwinds from the macroeconomic environment as decision-makers delay unnecessary IT spending. Moving forward, I forecast strong growth especially as China’s economy reopens.
A standout segment for Alibaba was its logistics segment Cainiao, which reported a rapid 27% revenue growth rate in the third quarter to $2.49 billion. This business is expected to be the first to IPO on the Hong Kong stock exchange in 2023, and will be valued at ~$23 billion, or $43 billion if the company can maintain a price-sales ratio of 4 and meet the forecasts I have estimated (more on this below).
Advanced post-breakup valuation breakdown
Valuing Alibaba is fairly challenging given the company is going through a split. However, in order to estimate the value of the company, I have created a “sum of the parts” valuation. The goal of this is to estimate the value of each segment after the split and to see if it truly does have the potential to unlock shareholder value.
As shown in the table below, I have estimated growth rates for the next 12 months for each segment. For the total company (pre-split), I have estimated 8% revenue growth, up from just 2% reported in the third quarter. I expect this to be driven by China’s reopening and the country's official GDP growth forecasts. I follow a similar train of thought for the China Commerce segment, which I forecast to generate 5% revenue growth for next year as opposed to the -1% reported for the recent quarter. This gives a total revenue forecast of $103.82 billion, which at a conservative price-sales ratio of 3.3 would give the China Commerce segment a valuation of $343 billion.
For the Cloud segment, I forecast its revenue growth rate to double from 3% to 6%. I expect this to be driven by the aforementioned growth trends with regards to the Cloud, which I expected to be bolstered by the digitization of China’s enormous manufacturing sector. This gives me a revenue forecast of $12.3 billion for the Cloud segment over the next 12 months. To put things into perspective, this is substantially smaller than Amazon's (AMZN, Financial) Cloud segment, AWS, which reported revenue of a staggering $21.4 billion in just the fourth quarter of 2022 (not the full year) and is still growing at a 20% growth rate. Therefore, given AWS doesn’t operate in China, Alibaba has an opportunity to capture more of the market in the country. It is already the market leader in China with a ~37% market share according to data from China Internet Watch. If I give the Cloud segment an estimated price-sales ratio of 6, then that gives me a potential valuation of ~$74 billion. It should be noted I have added the higher valuation multiple because the Cloud segment will be classed as a pure play tech company with the potential for high margins and a huge total addressable market.
Moving on to the next segment, I have forecast its International Commerce segment to increase its growth rate from 18% to 19%, over the next 12 months. This is just a 1% difference, as I expect exports will be impacted by the recessionary environment forecast for the Western world. With a projected price-sales ratio of 3, I get a valuation of ~$37 billion.
I expect its Cainiao segment to continue to fly with a rapid 28% revenue growth forecast, up from 27% prior. Logistics is a difficult business for new entrants to compete in due to high setup costs, and thus it is clear this business has competitive advantages. Therefore, as the company has its own IPO, I imagine this will be a popular one with investors. If I give this segment an expected price-sales ratio of 4, I get a valuation of ~$43 billion post-split.
Its Digital Media and Innovation segments reported growth rates of -6% and -20%, respectively, in the third quarter. Therefore, I have conservatively forecast those rates of decline to continue. However, as China’s economy is reopening, Alibaba’s movie segment will likely benefit. You may have noticed that Alibaba announced a split into six businesses, but currently trades with seven segments, as I have shown in my table. We don't know for sure what the breakdown of the six final businesses will be, but I have added together its two smallest segments, Digital Media and Innovation, which I believe are the most likely to be clumped together.
Bringing everything together, I get a total valuation of the full sum-of-the-parts business of ~$530 billion. At the time of writing, Alibaba’s market capitalization is ~$273 billion, and therefore the company has a margin of safety of ~94% according to my estimates.
Without the split, Alibaba stock looks to be undervalued by ~28% at my projected valuation of ~$383 billion, which I have derived from my separate DCF valuation model of the full company together.
Final thoughts
I believe Alibaba splitting into separate businesses will be a positive for existing shareholders overall, unlocking greater shareholder value. Each business is likely to become more agile, and my valuation model indicates a greater value from multiple expansions. For existing investors, I imagine the stock will be split and divided based upon segment revenue and the timing of each IPO. Of course, there are risks with this strategy given the IPO market is down substantially from the bull market in 2020. Therefore, we could see a couple of the IPOs crash and burn, so investors should take this into consideration.
