CTI27 Notes – Alibaba 4Q19

Disclaimer: These notes are shared for informational and educational purposes only. THIS IS NOT INVESTMENT ADVICE.

This post covers Alibaba’s considered Hong Kong listing, BABA’s May share price decline, declining EBITA margins, “margin drag” segments, and concludes with thoughts on the growing “wallet share” strategy of ecosystem apps.

These notes were prepared for episode 27 of China Tech Investor podcast, recorded on June 6, 2019. These notes were prepared before Alibaba released their 20-F on June 6, 2019.

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Recent News & Share Price Decline

• Alibaba’s HK listing looking even smarter right now, with Marco Rubio’s proposed law [1] to have companies listed in the US adhere to US accounting standards & oversight or be de-listed.
  • Comment: This will likely lead to a de-listing spree of the quality US-listed Chinese companies because the accounting oversight is a regulator-to-regulator matter. The quality Chinese companies would likely relist in either Hong Kong or possibly the New Tech Board being launched in the mainland if it goes well.
• 4Q19 earnings release [2] filed on May 15th 2019, discussed below
• 2019 Form 20-F [3] filed with the SEC on June 6th 2019

Alibaba’s share price has seen a 24.2% decline since the Trump Tariff Tweet.

Share price decline likely impacted by:

1. Trump’s tweet [3]: “325 Billion Dollars of additional goods sent to us by China remain untaxed, but will be shortly, at a rate of 25%… The Trade Deal with China continues, but too slowly, as they attempt to renegotiate. No!”
2. Declining margins

What’s going on at Alibaba?

So their revenue has been growing like gangbusters. The past 12 quarters had YoY revenue growth of 41% or higher. The lowest was 41% in Q3’19 (Dec’2018 quarter). The average has been 56%. The highest was 61%, which happened 3 times in the last 12 quarters. Nothing short of amazing.

Moving down to EBITA (no Depreciation in there). It’s also amazing, but the range of YoY growth is larger, from 1% to 71% in past 12 quarters. Average is 32%.

What’s more important is the EBITA Margin. In the most recent quarter, we are looking at 22% EBITA margin, or 28% on FY basis. That compares to a year ago 27% quarterly, and 39% FY basis. So we’re seeing declining EBITA margins.

Now the question is why?

EBITA has components, and Alibaba breaks them out (thank you). And we can look there. And we see what I’ll call “Margin Drag” in the Cloud, Digital media, and Innovation Initiatives segments. That’s negative EBITA Margin. 

• Cloud has been improving (getting less negative), from -41% in March 3 years ago, to -5% in most recent FY period.
• Digital media has been worsening.
• Innovation initiatives is a bit all over, but usually worse than -100% margin

We also see a declining trend in Core Commerce EBITA margin from above 60% in FY2016-2017 to 42% in FY2019. 

This is most recently driven by consolidation of Local Consumer Services, New Retail, Direct import, and Cainiao Network. (BTW, this consolidation helps revenue growth, but because these are loss-making business segments, it hurts EBITA). We’re looking at a negative EBITA of RMB 25.4B for these businesses for FY2019. We don’t have much historical disclosure around these, but that’s compared to negative RMB 8.8B a year ago.
In order to remove these impacts, Alibaba presents a special adjusted EBITA called “Marketplace-based core commerce adjusted EBITA” (MbccaEBITA). This figure has grown 31% YoY.

While that growth is great, the MbccaEBITA margin has declined from 49% to 43%. So the margin decline is also impacted by something else. 

What that is exactly, is difficult to determine. It’s probably related to international expansion & Lazada switching from 1P to 3P. Though, it could also be mixture of macro, competition (Pinduoduo), traffic costs, or something else. Welcome any feedback here.

Earnings Call Highlights

Joe Tsai chimed in on general macro concerns in China. Saying Alibaba benefits from long-term secular trends. He sees a long-term shift to service-oriented economy (last 5 years losing manufacturing jobs) that is driving disposable income growth and continuous consumption. The “domestic consumption driven economy”. 

Competition with Pinduoduo was an unspoken theme on the call.

• Expansion into T3 and lower cities. 70% of new users were from T3 or lower. But will be conservative on monetizing the traffic from these new users.
• Daniel Zhang: Taobao is positioned as a consumer community, value prop is in-depth selections and discovery – and the *fun* of discovery. While Tmall is very high-quality product and services with high degree of certainty.

Daniel Zhang: Ele.me is an important on-demand delivery network, serves not only ele.me but also other businesses, like recent Starbucks collaboration. // Hmm, Starbucks is food, like ele.me, hard to see how that’s really a *new* area. More that it can form the basis of a business relationship with a company like Starbucks.

Maggie Wu: Less focused on margins, more focused on profit growth. // Getting bigger, making more RMB as opposed to operating more profitably. 

Concluding Thoughts

There’s a general trend in e-commerce in China to gain consumers “wallet share”. This is the goal driving the ‘ecosystem e-commerce apps’. I think the idea is to get a larger piece of consumers consumption onto their platform/ecosystem, where it can be collected and analyzed. The final goal being to sell marketing services with better efficiency (ROI). It is yet to be seen whether this works and I don’t see anywhere on the planet that has figured out a profitable business model for 3rd party delivery, ride hailing, etc. I hope these companies have (1) analyzed the incremental unit economics and (2) are seeing incremental improvement or even better, profitability. 

What’s obvious is the margin destruction will continue for the foreseeable future for Alibaba. How far will Ali go? How far will their competitors go? How much capital will be deployed in the fight? And what will be the treasure for the winner(s)? 

Sources:

• [1] Rubio’s Oped – https://www.wsj.com/articles/you-cant-trust-a-chinese-audit-11559687739
• [2] Alibaba’s 4Q19 Earnings release – https://alibabagroup.com/en/news/press_pdf/p190515.pdf
• [3] Trump’s Tariff Tweet – https://twitter.com/realDonaldTrump/status/1125069836088950784