Monthly Archives: October, 2014

Alibaba Has Great Margins but Slow Pay Master

October 16th, 2014 Posted by Company Research Report, Uncategorized No Comment yet

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Company Research

About the Company

Alibaba Group Holding Limited (BABA) is an online and mobile commerce company. They were incorporated on June 28, 1999 through 18 people under the leadership of Jack Ma from Hangzhou, China. Alibaba works in wholesale and retail online marketplaces together with the its related companies. They also offer advertising and marketing services and other services such as electronic payment, cloud-based computing and network services and mobile solutions.

How does the company make money? 

Alibaba’s main source of revenue is the three retail marketplaces; one wholesale and two international. They offer a platform for third parties to provide technology infrastructure and marketing online for cloud computing services and internet infrastructure services. Cloud Computing intends to support its commerce ecosystem through providing distributed computing infrastructure in handling large volume of data and traffic generated by the company’s online marketplaces.

Do you know that Alibaba also provides payment and escrow services? Yes. They have contractual arrangement wherein third party receives and disburses money or documents for any transactions made in Alipay. As an e-commerce company, they have Taobao Markeplace, Tmall and Juhuasuan where people can buy stuffs online. In addition to its three online marketplace, Alibaba also have 1688.com, AliExpress.

Moreover, they also have small and medium enterprise (SME) loan business. The company provides micro loans to vendors on its wholesale and retail marketplaces.

As operators of their “ecosystem” as a platform for third parties, they generate revenues from China and international commerce retail and wholesale, cloud computing and internet infrastructure and others through online marketing services and commissions. Online marketing services includes  P4P marketing fees, Display marketing fees, Taobaoke commissions, Storefront fees, Commissions on transactions, Placement fees and Fees from Memberships and Value-added Services. Alibaba does not stop there and continue expanding their ecosystem to maintain the health and sustainability of its marketplaces. That is why they are the largest online and mobile commerce company in the world in terms of gross merchandise volume in 2013 of 529 in billions of Renminbi (RNB). Also, their three China retail marketplaces, generated a combined GMV of RMB1,833 billion (US$296 billion) from 279 million active buyers and 8.5 million active sellers in the twelve months ended June 30, 2014.

BABA competes with Tencent and Baidu. Tencent and Baidu has market capitalization in USD of 135.50B and 74.34B compared to BABA’s 216.37B.

Who is running the business and what is their background?

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First off is Mr. Jack Ma, the Lead Founder and Executive Chairman of Alibaba Group Holding Limited. In 1999, he was the Group Chairman and Chief Executive Officer (CEO) with the overall responsibility for strategy and focus. Later in 2013, he stepped down as CEO to concentrate on the Group’s business strategy and development. He is a board of director of SoftBank Corporation and Huayi Brothers Media Corporation. He is also served as chairman of The Nature Conservancy’s China board of directors. Mr. Ma graduated in Hangzhou Teacher’s Institute with a bachelor’s degree in English.

Next is Mr. Jin Jianhang who serves as the President of Alibaba Group Holding Ltd since August 2014. He is a member of Alibaba’s founding team and served as senior vice president of corporate affairs from September 2009 to July 2014. As a founding member, he had served management roles like heading the marketing and website operations functions for one of their marketplaces. From 2008 to 2009 he was the general manager of China Yahoo! (later Yahoo! Koubei). He was the vice president of human resources and CEO office from 2006 to 2007.  He received a bachelor’s degree in journalism from Fudan University.

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Ms. Maggie Wu is the Chief Financial Officer for Alibaba Group Holding Limited since e May 10, 2013. She is in-charge for the company’s overall financial management like operations finance, reporting, internal control, tax and treasury as well as corporate finance and audit. She first joined Alibaba in July 2007 as chief financial officer of Alibaba.com. In mid 2012, she co-lead the privatization of Alibaba. After that, she served as deputy chief financial officer of Alibaba Group where she is responsible in overseeing key aspects of the company’s finance organization. Prior to Alibaba, she was an audit partner for 15 years at KPMG in Beijing. She is a member of the Association of Chartered Certified Accountants (ACCA) and a member of the Chinese Institute of Certified Public Accountants. Ms. Wu has a bachelor’s degree in accounting from Capital University of Economics and Business.

Value Investing

Balance Sheet

This focus on the asset, liability, and equity ending balances account of the Company BABA.

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BABA’s current ratio are stable with the exception of 2012 when it peak at 2.37. Their quick ratio also trend up in 2012 at 1.9 but it retracted lower than previous years. Their total current asset growth has increases of 19, 111, 55 and 57 percent. This shows an increased in 2012 current asset, thus this accounts for the increased in its current ratio. Their total current liabilities have growth of 9, 69, 104 and 56 percent. It is noted that current ratio decreases in 2013 because of the sudden increase in their current liabilities. Summing it up, BABA has enough current asset and cash to pay off its current liabilities.

Their solvency ratios have increased in 2012 and have been recovering from a low of .34 in 2013. It drastically increased in 2012 of 431 percent because of the sudden trend up in net income from continuing operations. In 2013 the decrease was due to the increase in their total short and long term debts. In 2014, BABA’s solvency ratio increases 79.4 percent, because net income increased 171 percent despite the increase in total debts of 47 percent.

Debt to equity ratio was relative low for the pass three consecutive years of not more than 17 percent.  Starting in 2013 the company has been increasingly relying on debt of 2075 percent growth and a negative stockholders’ equity of -24 million Renminbi. In 2014 debt to equity ratio increased abruptly to a high of 140 percent for total debt growth of 47 percent.

BABA as seen in their balance sheet current and quick ratios means good liquidity, they can pay off current obligations as it becomes payable. Analysing behind the scene a question comes to mind why the sudden gaps in amounts from 2011 to 2012. The statements depicted a change in business strategy. Is this in preparation for their launching in New York Stock Exchange for their initial public offering or are they massively expanding into buying companies? The fact shows heavy increases in their total debts from 2011 to 2014. This means borrowing as they run out of money to the extent of depleting their stockholders’ equity in 2013 as reflected in their debt to equity ratio. Despite increases in total debts they still are solvent for the mere fact that net income from continuing operations jump up higher that previous years.

Efficiency Ratio

Is BABA efficient in its operations?

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BABA has declining day sale outstanding. It takes increasing days from 121 to 261days to collect its accounts receivable. Their payable period has a growth rate of -40, 1433, -3.3 and 18 percent from 2010 to 2014. This shows a drastic increase in 2012, telling us that it takes more than three months for BABA to pay its invoices from trade creditors and suppliers compared to its previous years of only 8 days. Their cash conversion cycle has a growth rate of 7, 3, 84, and 9 percent. This is the total number of days it takes for their products and services to turn to cash. As seen in 2013 the increase in days account for the increased in receivable and payable turnover.

Their fixed assets and assets turnover has been increasing year after years except for a slight dip in 2012. It shows that they have been more effective in using their investment in fixed assets to generate revenues so as with their assets. This measures  BABA’s ability to generate net sales from fixed-asset investments, specifically property, plant and equipment (PP&E). This accounts for the increase in their sales revenue, for lower profit margins tends to have high asset turnover due mainly to cutthroat and competitive pricing.

Income Statement

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Gross margin is 83.2, 80.4, 67.3, 71.8 and 74.5 with TTM of 73.5 from 2010 to 2014. This represents the percent of total sales revenue that the company retains after incurring the direct costs sold by BABA. Growth ratio trend of -3.5, -16, 6.7, and 3.7 percent.  And net margin is 26.44, 26.69, 21.11, 24.35, and 43.95 with TTM of 53.98. It is growing at 0.95, -21, 15, and 80 with TTM of 54 percent.

BABA gross margin increases only 3.7 percent in 2013, compared to 2012 of 6.7 percent. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and obligations. Their net margin shot up from 2011 decrease to 80 percent growth in 2013.

Dupont Analysis

In Totem we are using the expanded five-step model of DuPont analysis. This provides us with insights as to what is driving a company’s return on equity.

The extended five-step DuPont Model breaks return on equity down into five components: pre-interest pretax profit margin, asset turnover, interest burden, tax efficiency and leverage ratio. Their pre-interest pretax margin keeps going up except for 2012.  The decline was the effect of the increased in earnings before interest and taxes (EBIT) of 176 and sales revenue of 212 percent. Succeeding years increase because of lesser growth in sales revenue compared to growth in EBIT. Their asset turnover increases with a dent in 2011 of 0.21. This means they are using their assets to generate sales revenue. The decreased account for the sudden increased in assets and sales revenue growth. Its interest burden started in 2012, showing their borrowings through long term debts with interest expenses to be paid. Their tax efficiency depicted within the level of 83 to 86 with a declined in 2011 of 76 percent. This means taxes went down slightly as compared to 2011. Its equity multiplier has been changing year after year. This depicted an increased in their financial leverage.

BABA’s return on equity breaks down the net profit margin into its pre-interest pretax profit margin. This is to assess the impact of their interest expense associated with increased leverage and its tax burden. In this capacity the increased of EBIT account for their increased in total operating expenses especially its selling, general and administrative (SGA) due to their expansion in buying companies like Shenzhen One-Touch, investments in technology to improve their ecosystem and privatization of Alibaba.com. In 2014 SGA expenses has an equity-settled donation expense of RMB1,269 million or US$205 million relating to the grant of options to purchase 50,000,000 of our ordinary shares to a non-profit organization designated by Jack Ma and Joe Tsai.They have lower net profit margin as compared to asset turnover except in 2011 and this cause the increase of return on equity (ROE) in 2014. Aside from this, increase in equity multiplier also account for high ROE. So, BABA is highly leveraged and it would be risky for default.

Cash Flow Statement

This captures both the current operating results and the accompanying changes in the balance sheet.

Net cash provided by operating activities had been consistently increasing. BABA adjusted net income and this represents net income (loss) before share-based compensation expense, amortization, impairment of goodwill, intangible assets and investments, gain (loss) on deemed disposals/disposals/revaluation of investments, and one-time expense items consisting of the Yahoo TIPLA amendment payment and an equity-settled donation expense.

Their net cash used for investing activities increased in prior years with abruptly increase much more in 2014 but in 2013 it declined down 545 million RMB. BABA had used their cash on investments in PPE, purchases of investment, and purchases of intangibles. The decreased was from cash provided from properties, plant and equipment reduction, net of acquisitions and other investing charges.

And net cash provided by financing uplifted years 2010, 2012 and 2014 from short term borrowing, long term debt issued, and in 2013 issuance of common and preferred stocks. They used cash for financing activities in their long term debt repayment, redemption of preferred stocks in 2014, treasury stocks repurchase, cash dividend payments in 2013 and 2014 and other financing activities. Thus, this resulted a declined in 2011 and 2013.

BABA is globally inclined in sales revenues and this effect of exchange rate from Chinese Yuan Renminbi (CNY) in millions to US Dollars and other currencies. Their Alibaba.com, AliExpress and AliPay are receiving payments in different currencies so, this accounts for the changes. Net change in cash had decrease in 2010 of -112, but it increases back until a sudden declined in 2014 of -80 percent.

BABA adjusted EBITDA, adjusted net income and free cash flow, each a non-GAAP financial measure, in evaluating their operating results and for financial and operational decision-making purposes. Therefore, their operation cash flow from nothing in 2010 has improved 325 percent in 2011. This drastically change their operations, likes the introduction of Logistics Warehouse and Shipping and Logistics Management Services on AliExpress, unveils Mobile Cloud Operating System, agreement with Alibaba Group, Yahoo!, and SoftBank  on Alipay and 38 new leading Chinese B2C Sites in Taobao Mall. And in 2012 the talks of privatization of Alibaba, repurchase and restructure of Yahoo!, and launches Yu Le Bao Platform and Tmall global so as US based investments as among what has been happening to BABA. Their cash had been finance by short term borrowings and long term debts so as issuance of common and preferred stocks for them to expand their operations, purchases of investments, intangibles and properties, plant and equipment. To the extent the decrease in 2013 total stockholders’ equity was primarily due to the repurchase of their ordinary shares from Yahoo in September 2012 and the privatization of Alibaba.com partially offset by the issuance of ordinary shares to finance the repurchase.

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Cash flow margin has reached the peak at 69 and dip in 2013. Net cash flow from operations has increased drastically in 2012 of 325 compares to net sales growth of only 161 percent. And declined in 2013 is just the opposite meaning more increased in net sales and lesser cash flow from operation. This is how efficient BABA converts its sales revenue to cash for expenses and purchases of assets and investments.

Free cash flow margin high at 92, decreased in 2012 and subsequent steady at 83 and 82. The decrease in 2012 account for the increase in net cash provided by operating activities less the capital expenditure of purchases of property and equipment, excluding acquisition of land use rights for, and construction of, their office campuses in China and intangible assets, adjusted for changes in loan receivables.

BABA’s cash flow margin has higher percentage or it is more than 50 percent. This means they have more cash available from the sales, so as its free cash flow ratios. The more free cash flows embedded in the operating cash flows the better it is. It is a very good indicator of financial health of a company.

Totem’s Method

Totem  method adopt the investment style which is applicable to the company. One valuation style is that seeks out undervalued companies whose stock price are temporary down, but whose fundamentals are sound in the long run. The financial calculator is our main instrument in computing the equity selection. This is to know whether BABA is under or overvalued.

BABA has a growth rate of 22 percent as computed base from present book value of 1.14 and future value of -3.78 from 2010 to 2014 and TTM. This resulted to a book value in 5 years of $10.26. Its average return on equity is 37.33 percent, the return on book in 5 years is $3.83 and the price in 5 years will be $172.43. Using the industry P/E ratio of 45 than its current P/E ratio of 53.2 which is more conservative will get the present value of the stock of $74.55 and after margin of safety or total value of appreciation of $44.73. Their current market price as of October 13, 2014 is 85.12.

Since their official initial public offering in New York Stock Exchange, BABA has a stock price or current market price that reached a high of $93.89 in September 19, 2014. But stock price had decreased down in September 23, 25 and October 1 of $87.17, 88.92, and 86.10. And today October 13, 2014 it is $85.12 which is 47.4 percent more than its total value of appreciation. This shows that stock price is overvalued.

Relative Valuation

This is a comparative study on their book value, earnings, price to earnings and returns to help in the valuation of company BABA. These are methods for comparison, in valuing of a company. One is the book value per share with abrupt increase in 2012, downslide to -0.01 in 2013 and reverted back in 2014. This is the effect of their over expansion and buying of companies to the extent of having no equity and increased long term debts to finance its investments. Its price to earnings (P/E) ratio current is 53.2 compared to industry P/E of 45 which Totem used to have a conservative computation for BABA’s TTM P/E ratio is only 39.24. This is an important equity valuation multiple helping as defined the market price per share over its annual earnings per share. Their earnings per share are 0.29, 0.34, 1.69, 3.89 and 9.9 with TTM of 0.34 from 2010 to 2014. It is the monetary value of earnings per each outstanding share of BABA’s common stock. This increased for their net income from continuing operations increased abruptly especially from 2012 to 2014 due to change in their business strategy uplifting their online marketing services and others. So, as their return on equity declined in 2012 and abruptly increased in 2013 and 2014.

BABA’s book value was $3.09 which increased after a week from its initial public offering in NYSE to $3.78 per share. Earnings per share in 2014 show a $9.90 or 10 per share from only 0.29 in 2010. This is a very massive increase per share, due to the successful launching which was unmatched and exceed their expectations. Their return on equity (ROE) increased shows how well BABA uses its investment funds to generate earnings growth.

Conclusion

Totem’s basis of valuation is the company’s five years financial records wherein BABA’s has limited results of their financial performance trailing with progress. The fact that the company is overvalued at $85.12 per share as of October 13, 2014 and total value as compute is only $44.73. This would merit a buy when the share goes undervalued or risk it since to date market price still went down to $84.95.

As all knows, BABA is one of the best-positioned companies within the global internet services space, both inside China and around the globe. Their shares have climbed by 25% since its initial public offering last month. BABA’s growth is higher than that of the rest of the industry and it seems impressive and sustainable.

CITATIONS

https://www.google.com/finance?q=NYSE%3ABABA&ei=WXEdVIihAoatkgXYvoHYBQ

http://www.reuters.com/finance/stocks/companyProfile?rpc=66&symbol=BABA.K

http://www.alibabagroup.com/en/about/history

http://google.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=10205127-920-1972851&type=sect&TabIndex=2&companyid=934140&ppu=%252fdefault.aspx%253fcompanyid%253d934140

http://financials.morningstar.com/ratios/r.html?t=BABA&region=usa&culture=en-US

Researched and Written by: Nellyt

Note:

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