by Chaim Siegel of Elazar Advisors, LLC
Alibaba Group Holdings (NYSE:BABA) is solving two important global issues simultaneously. They’ve created a gateway for companies to finally enter China with ease and at the same time are offering a mechanism for Chinese citizens to do business locally as well as internationally.
This gateway is of course priceless.
Many multinationals have tried and failed to enter China. Chinese household incomes also have a huge gap below other economic powers. China’s median household income by many measures is 1/5 that of residents of the United States.
There is a huge void in reaching Chinese consumers that, until now, has not been bridged by anyone. As the go-between with a unique, first-mover positioning, the monetization potential for Alibaba as this dual purpose gateway with which to bridge the gap is of course essential, not to mention full of potential.
Many analysts have focused on the negatives of the Alibaba story such as the business structure, the SEC inquiry into its accounting practices and other risks. When comparing the risks to the opportunity, we think the opportunity—by far—wins out.
The market is huge. Alibaba is already performing, so it's proving its purpose.
If we close our eyes and imagine looking back years down the road it’s easy to see that Alibaba’s vision and positioning today were the reasons they won in China.
Laser Focus On Small Business
Founder Jack Ma, alongside Alibaba’s laser focus helping small businesses make this company a huge story for investors that want exposure in China.
They are helping local businesses find both local and global customers while also helping global businesses find Chinese customers. Alibaba is at the center of the Chinese marketplace opportunity.
If you ever wondered what the ultimate purpose of the internet was, and ever listened to Alibaba’s strategy, it’s easy to think that the internet was built for Alibaba. They make it seem as though the internet was built to reduce the roadblocks of doing business globally for both large and small merchants.
While Amazon (NASDAQ:AMZN) has its own incredible business model, at the core of Alibaba’s business model is a decentralization focus on outside sellers. Amazon of course has outside sellers, but their first business model was their own retail sales.
Alibaba’s vision to make the China marketplace a reality for locals and globals has positioned them as the go-to player to accomplish that. Meditate on that unique positioning for a moment.
The internet has always been a huge opportunity. China has always been a huge opportunity. But by helping small sellers reach a bigger pie, Alibaba is tapping into the biggest opportunity that exists, capturing the largest amount of potential volume.
That’s why dollars traded on their platform already surpassed Wal-Mart’s (NYSE:WMT) sales. Back in Q4 2015 Alibaba reported about $150B in GMV versus Wal-Mart’s $129B in sales. That’s proof they are the gateway to and from China that the world has been looking for.
Structural Risk
For US investors the business's structure has been tough to get one’s arms around. That said, there isn’t much choice if you want access and exposure to this huge opportunity. Part of the discount to the shares, now trading at $116, is likely due in part to its lack of transparency regarding segment ownership.
We don’t think that’s a risk though. Alibaba will still need the capital markets.
Jack Ma has said that he wants to raise money for “a rainy day” when he has money. Alibaba will want to raise money even if they don’t need it today. They need their shares to be valuable because they use their shares as a key method for outside investment and paying employees.
Jack Ma has a huge vision. He needs and wants access to future outside investment money. He’s not done and he doesn’t want to hurt that “trust” which will help in raising future funds.
The fact that he already “trailblazed” to raise money in the US is testament that he has his sights set high. He’ll want more money down the road. For that reason we don’t see him tarnishing his ability to raise big money.
Even if they were to “bring in” all of their nonconsolidated losses, last quarter the off-balance sheet losses totaled $223mm versus the company’s non-GAAP net of $3.2B. It’s manageable for investors.
For now there is a “land grab” to beef up competitive video offerings and infrastructure as there has been for other players such as Amazon. Companies are spending money today to capture current available market share with an eye toward the future.
Amazon had many years of investment in infrastructure through their income statement. Many companies are also racing to invest in synergistic businesses. Alibaba is not alone and relative to the profits, we’re not concerned.
As long as businesses are nicely profitable and growing we see upside to the share prices. The structure should not be a deterrent.
Social Business
In a way, Alibaba’s marketplace platform is a step ahead of typical social media platforms like Facebook (NASDAQ:FB) or Twitter (NYSE:TWTR).
Facebook and Twitter sell ads. Alibaba’s users sell products and make money, but they also use Alibaba as a social platform.
For that reason Alibaba has the ability to keep buyers and sellers glued to the network more intensively than a traditional social platform, because users are making money rather than just socializing. They are financially incentivized to stay on the network. That may be why Alibaba is finding success in advancing their offering and accelerating their marketing service revenues.
That will also help Alibaba’s success when offering video streaming and other services.
Cloud In China
While Cloud is smaller for Alibaba currently, the Chinese market has huge potential.
Many have said that the Chinese government is allowing Alibaba to build a lead over foreign entrants. That may be so. Alibaba has strategically offered to win government business at low or no cost, which helps their position.
We know cloud is the future of how businesses will transact. As China moves from on-premise to cloud, this is a huge opportunity for Alibaba in China, maybe more than for any other player.
Alibaba says the market is a $30B opportunity which would add to the company’s current $20B in revenues.
Failed Foreign Businesses In China
Alibaba has positioned itself as the gateway entry point for global companies.
The horror stories of failed entry into the Chinese marketplace are stacked as high as the gold rush that multinationals were expecting from the Chinese market.
Alibaba’s size, scale, and local know-how are going to benefit many Fortune 500 companies who want to enter China. That drives the virtuous cycle of selection driving users, driving more sellers and so on.
There have been multiple reports throughout the years of multinationals confidently marching into China only to find that doing business was much tougher than they expected.
Mattel (NASDAQ:MAT), Home Depot (NYSE:HD), Google (NASDAQ:GOOGL), and eBay (NASDAQ:EBAY) are only a few of the extremely successful companies that proved unsuccessful in China. Despite the known opportunity of selling to 1.3B people in China, companies without the expertise fail.
One of Alibaba’s goals is to make life easier for multinationals to enter China. Consumer goods partnerships already announced include Mattel, Mars and Nestle (SIX:NESN) and SAP (NYSE:SAP), Accenture (NYSE:ACN) and Softbank (T:9984) in cloud computing. Jack Ma also recently met with US President Donald Trump, with the intention of building this gateway.
Because of their positioning, by default Alibaba has become China’s business welcome center, thanks to their marketplace. Alibaba will only continue making it easier for multinationals to do business in China, which is a huge opportunity for investors.
Short Interest
The short interest makes up 13% of the float. Any good news should force shorts to cover. That helps the stock continue higher.
Stock Breaking Out Of A Huge Base
Without a smoking gun, shorts have a technical problem. The stock is breaking out of a huge base formed ever since the company went public. That will mean the stock could be hitting new highs, garnering investor attention and forcing shorts to cover.
Our Numbers
Our earnings numbers aren’t much different than the Street's. We get to $4.35 this year and $5.43 next year. The Street is at about $4.10 this year.
Given the huge potential, a 30-50% topline growth rate and impressive margins, we think 30-40X PE is fair.
That would give us a target of about $150 this year and $190 next year. We’re using a $170 target or about 50% upside from here.
Earnings Report
Alibaba is expected to report earnings May 18th before the open.
Conclusion
Alibaba is not expensive, it’s heavily shorted, and it’s breaking out of a huge technical base. Most importantly it has positioning in China like nobody else. The company is already accomplishing its goals, but we think Alibaba is early on with huge upside.
Locals and globals have had a tough time in China. Alibaba is changing that. That’s incredibly valuable.
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