Alibaba’s shares have been extremely volatile over the past few weeks as uncertainty swirled around China’s tech sector. But with valuations near rock bottom, investors with an appetite for risk can consider scooping up some shares.
Tan De Jun | Published on 24 Dec 2021
• Alibaba’s shares have been extremely volatile over the past few weeks, caused by a combination of factors such as missed earnings, slowing economic growth, and the threat of delistings.
• Although the domestic commerce segment is likely to face headwinds in the near future, the growth momentum of other segments such as cloud computing is expected to accelerate.
• With China’s economic recovery showing signs of losing momentum, regulatory pressures may start to ease as China’s adopts a softer stance to bolster its economy.
• Based on the sum-of-the-parts methodology, we arrive at a target price of HKD 257 for Alibaba which translates to an upside potential of approximately 125%.
Shares of Alibaba (HKEX:9988), the most high profile company in China’s tech crackdown, have been extremely volatile over the past few weeks, as news of DiDi’s impending delisting as well as China’s slowing economic growth shook investors.
Adding to the volatility was the release of Alibaba’s 2Q FY22 results in mid-November. Despite delivering total revenue growth of 29% year-on-year, Alibaba’s shares experienced a fresh round of sell-offs as the company missed consensus revenue estimates by a small margin (Table 1).
The company’s earnings per share (EPS) also took a hit as Alibaba stepped up investments in key strategic areas that have exhibited robust growth in operations, such as Taobao Deals, local consumer services, and community marketplaces, laying the groundwork for future growth. It also extended more support to merchants, leading to an increase in operating expenses for the period.
Table 1: Alibaba posted weaker-than-expected results for 2Q FY22
|Revenue (CNY millions)||200,690||206,173||(2.66%)|
|Non-GAAP EPS (CNY)||11.20||12.37||(9.46%)|
|Source: Company Data|
Strategic investments made today should pay off in the long run
In another blow to the already fragile market sentiment, the company revised its full year FY2022 revenue growth guidance down to 20-23% year-on-year from the previous estimate of approximately 30%.
Alibaba’s management attributed the softer guidance mainly to the weaker outlook for its domestic commerce segment. Looking ahead, the domestic commerce segment faces a number of headwinds, such as slowing consumption growth and greater competition in the e-commerce space, both of which are expected to have an impact on its revenue growth rate.
In the third quarter of this year, China’s GDP grew 4.9% from a year ago, the slowest pace in a year and lower than the consensus forecast of 5.2%. The uninspiring growth raised concerns that the economic recovery it enjoyed since mid-2020 was losing its momentum amid property woes and sporadic COVID-19 outbreaks across the country (Figure 1).
A slowing economy may hurt consumer confidence and weaken demand, which could have a negative impact on Alibaba’s domestic commerce segment.
Figure 1: China’s economy grew at a disappointing 4.9% in 3Q21
On the bright side, growth in other segments such as cloud computing and international commerce is expected to accelerate. Cloud computing, in particular, is a promising segment that is widely expected to be the next profit engine for Alibaba alongside its commerce business.
Cloud spending in China has been growing at a blistering pace over the past few years as China continues to push ahead with its digital transformation efforts. And with the pandemic fuelling demand for cloud services, China’s cloud spending topped USD 7.2 billion in the third quarter of this year, an increase of 44% year-over-year.
With a market share of nearly 40% in China’s cloud computing industry, Alibaba, the country’s largest cloud service provider has benefitted immensely from the rising demand for cloud services. In 2Q FY22, Alibaba’s cloud revenue rose by 33% compared to the same period a year ago. The unit also achieved its fourth consecutive profitable quarter as it starts to reap the benefits of economies of scale (Figure 2).
Figure 2: Alibaba Cloud continues its robust growth
Back in October, Alibaba unveiled a new server chip designed in-house by its chip development unit as it looks to gain an edge over its peers. The processor, Yitian 710, comes with better performance and improved energy efficiency and will be gradually deployed across its data centres.
With a strong foothold in China, the company has also began ramping up its expansion plans into other regions across Asia Pacific, challenging the likes of its western peers such as Amazon and Microsoft. It plans to open its first data centres in South Korea and Thailand in 2022.
Overall, despite the softer guidance, we think that the investments into key strategic areas shows that the company is forward looking, and we expect to see these investments pay off in the future.
Regulatory pressure could start to ease as economy slows
During the Central Economic Work Conference held in early December – a meeting that outlines the country’s economic policies for the year ahead – Chinese leaders emphasised that stability will be the top priority for the nation going into 2022.
This comes as recent economic data seems to suggest that the economy may be losing its momentum, as retail sales, fixed asset investment, and GDP growth all fell short of expectations. And with 2022 shaping up to be a politically important year for China due to the 20th National Congress, we believe that the government will likely take a softer stance to prevent the economy from falling below its growth target.
Along with this, regulatory pressures are also likely to ease sooner or later as the government wraps up most of the antitrust investigations while companies become more familiar with the new policies and direction.
Delisting is not a major concern for now
With regards to the concerns over a potential delisting, here are a few things that investors should be aware of.
First of all, a delisting of Alibaba’s ADRs means that the company will be cut off from a large pool of international investors. The NYSE, is after all, the largest stock exchange in the world, and the very news of an upcoming delisting will likely dull investor sentiment, affecting valuations as investors may not be willing to pay as high a multiple as they did in the past for Alibaba.
In addition, the company will have to provide an exit option for its US shareholders, such as buying back shares at an agreed upon price. A share buyback means that the company will have to fork out a sum of cash, which could have otherwise be invested back into the business.
All is not lost.
Alibaba may also elect to convert its ADRs into HKEX listed shares. It’s Hong Kong ordinary shares and NYSE-traded ADRs are fully fungible and can be freely converted in both directions. The conversion ratio for Alibaba is eight shares for every ADR. However, doing so may give rise to logistical issues such as transfer fees and other associated costs.
Alternatively, investors who do not wish to be bought out or have their ADRs converted into shares may continue to trade their ADRs in the OTC market, although the liquidity there is expected to be much poorer compared to trading on a stock exchange.
On the bright side, we think that a delisting is unlikely to occur in the near future as US rules state that foreign companies may only be delisted should they fail to comply with audit requirements for three consecutive years. This means that the first delisting will only happen in 2024.
Considering that three years is a relatively long time, many things could potentially happen, such as the US and China eventually reaching a compromise on listing requirements. Therefore, we think that a delisting should not be a major concern at this point in time.
Valuations are near rock bottom
Driven by a combination of macro and company specific factors, Alibaba’s shares are near rock bottom after a rout erased nearly half its value since the beginning of the year. As it stands, Alibaba’s shares are currently trading at just 14X FY2022 earnings, significantly lower compared to its three year average PE ratio of 25X.
To reflect the challenges that the domestic commerce segment may face over the next few years, we lowered our revenue and net profit margin estimates. Applying our new estimates to the sum-of-the-parts valuation methodology, our estimated target price for Alibaba is HKD 257, which translates to a potential upside of 125% based on a closing price of HKD 113.3 as of 24 Dec 2021.
Table 2: Sum-of-the-parts valuation for Alibaba
|Business Segment||Shareholding||Valuation (CNY millions)||Valuation Methodology||Multiple||Weighted Valuation (CNY millions)|
|Ant Group||33%||132,000||Estimated market value||1X||132,000|
|Total value (CNY millions)||5,084,075|
|# of shares (millions)||2711|
|2023 Target price (HKD)||257|
|Current share price (HKD)||113.3|
|Source: Bloomberg Finance L.P. Company Data, iFAST EstimatesData as of 24 Dec 2021|
While there is always a possibility that share prices may decline further, we think that at current levels, the upside potential more than compensates for the downside risk. Long-term investors with an appetite for risk can consider taking a position in Alibaba (HKEX:9988).
Table 3: EPS table for Alibaba
|FY 2021||FY 2022E||FY 2023E||FY 2024E|
|PE Ratio (X)||27.1||13.92||12.14||10.26|
|Source: Bloomberg Finance L.P.Data as of 24 Dec 2021|