Alibaba - Pre IPO Fundamental Analysis

  • Alibaba has grown sales as well as net income at a fairly high rate.
  • Alibaba has high profitability, and continues to expand into compatible opportunities that work well with its ecommerce ecosystem.
  • Alibaba has risk factors due to the political climate, and legal interpretation of special purpose entities.
  • Alibaba IPO will be a wildcard event, as further dilution, paired with Yahoo liquidating its position may impair Alibaba valuation.

Alibaba fundamental analysis

Alibaba (BABA) may have significant growth potential given the favorable dynamics of an emerging Chinese middle class paired with opportunities to grow the business in international markets. The company continues to launch services that are highly compatible with the company’s core segments. However, the IPO poses significant risks, and it may not be a very good idea to chase after the stock until there’s some stabilization in the price action.

Alibaba revenue and Net Income chart

Alibaba revenue and Net Income
Source: Ycharts

Alibaba reported $8.45 billion in sales, and net income of $3.76 billion in FY2014 with a net profit margin of 44.5%. This level of profitability is abnormal for an ecommerce website, but because the company operates as an intermediary, fee income from its various e-commerce platforms has low overhead/high margins.

Alibaba Earnings per share

Alibaba earnings per share
Source: Alibaba

Alibaba has grown its earnings per share (EPS) on an RMB basis at a rate of 83.76% over the last  three fiscal years. This rate of growth was driven by revenue growth rates exceeding expense growth and the continued improvement on various key performance indicators (gross merchandise volume, which is comparable to the enabled commerce volume that eBay reports to its shareholders).

Alibaba GMV growth and mobile penetration chart

ALibaba GMV and penetration
Source: Alibaba

Alibaba has grown its GMV over the prior three years at a fairly consistent rate, and the reason Alibaba has so much gross merchandise volume (total transactional volume through all of its web market places) is driven by how the company offers a myriad of e-commerce platforms, payment services, and cloud services. The dominance in many of these categories helps to support Alibaba’s valuation. The platform for imports/exports (wholesale) Alibaba, and Chinese auction website (TMall), and the company’s direct-to-consumer business Taobao marketplace, gives the company significant economies of scale.

Another way to look at Alibaba is to combine eBay marketplace, Amazon, PayPal, and Amazon Web Services all under one single umbrella, except with an emerging middle class in the most populous country behind it, paired with international growth initiatives, and further expansion opportunities in warehouse and distribution through China smart logistic network (perhaps Alibaba will become the UPS/FedEx of China as well).

The various businesses under Alibaba’s umbrella do share significant synergies, and while Chinese competitors do exist; there’s none that operate at the same scale of Alibaba in many of the categories that it offers services in.

Alibaba valuation and risk factors

There’s a wide range of numbers for Alibaba IPO valuation. In this specific article the figure we will use is $200 billion. Assuming the valuation can be supported at $200 billion, the stock will trade at 52.4 times net income, which comes at a .62 PEG ratio for its 3-year prior earnings growth rate. The 3-year CAGR is being used, because the company exhibited significant EPS growth in the trailing twelve month period, and the company has not offered full-year earnings guidance (which will most likely occur in its first officially reported fiscal quarter.)

The 3-Year .62 PEG ratio is compelling, and as a general rule a PEG ratio below 1 is considered to be extremely good. However, the stock may end up trading at a significantly higher valuation following the IPO, or it may be heavily discounted on a discounted free cash flow basis as there are on-going concerns by investors over the interpretation of structured investment vehicles, and there’s also on-going political tensions coming from Russia (China’s neighbor). Historically, global trade relations between the United States and China have remained stable, but the on-going political risk carries heavy repercussions for Alibaba’s whole sale business, and since it’s a legal holding company, subject to the jurisdiction of China there’s always the risk of eminent domain. The on-going capital investment phase may limit free cash flow growth as well, which is another factor to consider.

However, aside from those three factors, competitive dynamics heavily favor Alibaba in China. Furthermore, Alibaba can expand its ecommerce platforms into other markets.

Conclusion

Alibaba IPO will be a wildcard event. On one hand Yahoo plans to liquidate 140 million shares, on top of that Alibaba will issue shares that may dilute up to 10% of Alibaba’s total share outstanding figure. The dilution impact, paired with heavy selling from an established equity holder may cause the stock to decline on the day of IPO.

However, on a PEG basis the company is attractively valued, and the outward growth potential is there, so the heavy selling may be met with significant buying.

Therefore investors may want to avoid the Alibaba IPO entirely and wait a couple of months on the sidelines until earnings guidance figures come in, along with further coverage from sell-side analysts.

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