Seeking Alpha

Alibaba: Still A Compelling Bargain

|
About: Alibaba Group Holding Limited (BABA)
by: Integrator
Summary

Alibaba’s share price has been pushed around by the news flow around the trade war.

The business still represents the best way to play the secular growth in Chinese consumer spending.

Payments and cloud computing represent major long-term growth markets for the business.

Valuation is very compelling.

Alibaba (BABA) has had a fairly nice bounce off its 52-week lows; however, I still believe that it is still materially undervalued and that it is a business that can confidently be bought now and held for the long term. The business is a long-term position for Project $1M and one of the 5 great businesses that I'll never sell.

Long-term play on the growth of the Chinese consumer

As of 30 June, BABA had roughly 730M annually active buyers across its China marketplaces. This represents above 50% of the Chinese population. Taobao in particular enjoys strong brand loyalty among a younger generation of Chinese consumers. A platform with the greatest number of buyers attracts the greatest number of sellers and provides strong monetization for Alibaba. Given Alibaba already has more than 50% of the Chinese market, it has achieved a level of penetration where it becomes very difficult for competitors to make inroads given the substantial network effects within the business. Consumers want to shop where there are the most merchants and merchants want to shop were there are the greatest number of consumers. Merchants also don’t want to go to the trouble of listing across multiple properties, given the difficulty of maintaining and updating listings, inventory coordination and other fulfillment issues. At the company's recent investor day, Alibaba announced that it has its sights set on bigger goals. The business believes it can achieve 1B active consumers by 2024, and almost $1.4T in annual gross merchandise by this time.

The reason this is entirely possible is the expected long-term growth of the Chinese middle class in both urban and regional centers. China is expected to have a middle class of almost 800M by 2030, up from only 300M today. This rising middle class with increased consumption power will help in the transformation of the Chinese economy from a manufacturing economy to one that is more oriented to domestic consumption. This sustained, steady increase in consumption over the next decade across both a larger number of people and greater consumption per person will be a significant boom to Alibaba, in particular.

Much of this growth in the Chinese middle class will come from the regional and rural sectors of China, and thus having a national delivery and logistics network to be able to service these markets will be of paramount importance. There are a very small handful of Chinese e-commerce players who can execute seamless logistics and delivery across such a large area of geographic coverage and population density, and Alibaba would arguably be at the top of that list. In fact, the opportunity in regional Chinese markets is something Alibaba itself acknowledges, citing a penetration rate of over 85% in the urban centers of China, but only 40% in the rural areas. This untapped market in rural China represents a tremendous opportunity for Alibaba.

Investment in Ant Financial is a positive

Alibaba just concluded a deal with Ant Financial under which the previous agreement with Ant for a share of profits in Ant has been scrapped, in exchange for a 33% equity stake in the business. Ant has been most recently valued as high as $150B and is probably best known for its Alipay service, the mobile wallet which allows users to pay in-store and online. The business has 28M merchants who accept the service, with AliPay itself having over 900M annual active users as at June 2019. A more tightly integrated commercial offering between the two businesses could open up the way for Alipay to steer Alipay users back into Alibaba's broad ecosystem of e-commerce properties. Payments also tends to be another very sticky service, with significant network effects built in. Consumers only want to use payment instruments that are accepted at the broadest set of retailers, and retailers don't want to accept payment instruments that don't have at least some critical mass. With almost 900M mobile wallet users and 28M merchants, Alipay has well and truly passed that critical acceptance threshold. While Tencent (OTCPK:TCEHY) has been encroaching on Alibaba's payment dominance, capitalizing on the steady growth of its Wechat property, the market is big enough to be supportive of a couple of payment players with significant reach.

Proxy for growth of South East Asia e-commerce

What's often neglected with Alibaba is that the business represents more than just a play on China, and that Alibaba has over 130M customers outside of its core China business, through both its cross border and global retail commerce businesses. Alibaba's Lazada is the dominant retail e-commerce play across much of South East Asia. Lazada has operations in Singapore, Philippines, Malaysia, Indonesia, Thailand and Vietnam. The South East Asian region has over 200M internet users, whose per unit incomes are growing strongly as economic development accelerates across the region. Also, with existing penetration of e-commerce platforms still relatively low (less than 10%), the potential for strong growth in the region exists over time. The e-commerce market in South East Asia is generally characterized by significant fragmentation, with few if any dominant players. The handful of emerging players (such as Sea Limited (SE) in Thailand) have a lack of meaningful market share, affording Lazada and Alibaba an opportunity to dominate e-commerce growth in the region.

Cloud computing represents a significant new market

The market opportunity in the industrial internet in China will be sizable. Enterprise cloud computing and the Internet of Things will be key enablers of this shift, and the consumption of public cloud computing services in China will be almost $11B in 2019, with an expected 5-year annualized growth rate of nearly 44%, according to IDC.

The industrial internet market is expected to be worth $145B in 2023, with China expected to claim almost 1/3 of that value. Much of the value creation here will not only be the sensors driving the data collection but the platforms and value added services that help derive insights from the data. The enterprise cloud computing market will be a central element in realizing the value of the industrial internet.

Alibaba dominates the enterprise cloud computing market, and as an early entrant into the market, it has been able to acquire almost 42% market share. BABA holds a commanding lead over all the other players in the market, with Tencent coming in a fairly distant number two with under 12% market share. Alibaba’s dominant position here is significant because cloud infrastructure as a service is ultimately a game of economies of scale and cost advantage. The greater the utilization of cloud infrastructure, the lower the incremental cost per user to the cloud provider. Ultimately, the player with the most scale will have a unit cost advantage in delivering cloud compute.

China Cloud Computing Market Share, IDC 2019

Valuation

Alibaba has a very compelling valuation on most metrics compared to its peer group. The business trades at just 25x forward earnings and 21x cash flow, compelling for a company that continues to grow revenue at near 40% and whose long-term earnings growth is expected to be almost 26%. In fact, BABA trades at a PEG of just 1.1.

When compared to peers Amazon (AMZN) and MercadoLibre (MELI) which trade at a forward PE of 45 and 111, respectively, Alibaba looks like a bargain for the expected growth on offer.

Disclosure: I am/we are long BABA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.