Alibaba (BABA, Financial) has declined by 25% year-to-date, and the decline in the stock has been accelerated by the recent carnage in Chinese equities. While China’s GDP growth is likely to remain muted in the coming quarters, I believe that the recent correction is a good opportunity to accumulate Alibaba. This article discusses the factors that will trigger renewed upside for Alibaba. I must mention at the onset that Julian Robertson (Trades, Portfolio) of Tiger Capital Management has increased his stake in Alibaba according to last quarter holdings, and he now holds 636,878 shares of the company. This underscores the point that Gurus see value in the stock.
Before moving on, I would like to briefly talk about the Chinese economy. Investments still make up over 50% of China’s GDP and there are excesses in the manufacturing as well as real estate sector (in several regions). In the coming years, I have strong conviction that manufacturing and investments as a percentage of GDP will decline, while consumption as a percentage of GDP will trend higher.
If China’s economic growth has to sustain at 5% to 10%, consumption will drive that growth and I believe that households are well positioned for spending in the coming years with a swelling upper-middle class. Considering this factor, I believe that Alibaba is well positioned in a big consumer market. Therefore, from a long-term perspective, Alibaba is likely to grow at a steady pace and I believe that once the correction in China is over, the stock will resume its long-term upside.
While I will discuss the growth potential in China, it is important to note that Alibaba is also looking beyond China for growth and I believe that India is the best market outside China that can be tapped. Alibaba already has a dedicated e-commerce site for India and in February 2015, the company announced a 25% stake in One97 Communications, which is India’s mobile payments and ecommerce platform Paytm owner. Alibaba is also looking to buy a 25% stake in India’s second largest mobile phone company, Micromax. Therefore, the company’s growth intentions are clear outside China and this will provide long-term growth support.
Recently, Alibaba also announced expansion of cross border e-commerce initiative to enhance global trade between small businesses and the Chinese market. The initiative includes launch of 11 official country pavilions on its Tmall Global platform and cooperative partnerships between Juhuasuan, Alibaba's group-buying platform, and 26 foreign embassies in China. This will be a one-stop shop for popular products from a particular country for Chinese consumers. Through these initiatives, Alibaba is likely to increase strong global presence in the coming years. Currently, international commerce sales and wholesale makes up just 9% of the total revenue, but I believe that international contribution to revenue will increase meaningfully in the coming years. To put things into perspective, international commerce retail has grown at 53% for 3M ended FY15 as compared to FY14 comparable period.
Coming to Chinese markets, revenue and EBITDA growth remains robust with FY15 growth at 45% and 33% respectively. Importantly, the company’s free cash flow for FY15 was $7.7 billion, representing a 49% growth on a year-on-year basis. This is important to mention as Alibaba’s growth strategy has been inorganic recently, and robust FCF gives the company high financial flexibility to make big investments in high growth sectors and markets.
Just as an example, Alibaba is already the top cloud service provider in China, and I believe that investment in leading technology will translate into a higher growth trajectory for the company. The company’s cloud computing and internet infrastructure was just 2% of the total revenue, but the segment has witnessed revenue growth of 82% on a year-on-year basis.
It is also important to mention here that the gross market value of China’s commerce retail has been surging at well over 40% on a year-on-year basis, and this point is important to mention as it underscores the fact the China’s consumption is surging, even when overall economic growth is muted due to the manufacturing and investment sector. I expect the GMV of China’s e-commerce retail to surge higher in the coming quarters and Alibaba is likely to deliver strong quarterly results. The GMV is likely to increase in line with an increase in active annual buyers that has already increased from 255 million in March 2014 to 350 million in March 2015. With internet penetration still growing at a strong pace in China, I expect better times ahead. Another important point to mention here is that mobile revenue as a percentage of total revenue has been increasing at a robust pace and considering the growth of smart phones, I expect mobile revenue to have the dominant share of total revenue in the next 2-3 years.
Investors might point out that the company’s EBITDA margin declined to 49% in March 2015 quarter as compared to 58% in the December 2014 quarter. However, the decline in margin can be attributed to cost related to acquired business and investment in new initiatives such as cloud computing. Therefore, near-term decline in margin is not a point of concern.
Alibaba therefore remains on a high growth trajectory and the company has made several investments in the recent past that is likely to result in long-term gains. The steep correction for the stock in YTD15 is therefore a good accumulation opportunity with a long-term investment horizon.
