Breaking up is the right thing to do
Alibaba is planning to break its business into six parts. This comes after years of intense scrutiny of major technology companies by Chinese regulators, on top of having to navigate weaker economic growth and rising competition - particularly in its flagship e-commerce business. Each unit will have its own CEO and board - paving the way for separate listings as well.
The new structure
Alibaba's six business groups will be dedicated to e-commerce, cloud computing, local services, logistics, digital commerce, and media. Current CEO, Daniel Zang, will remain at the helm of the Alibaba holding company and will also head up its cloud business.
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Taobao & TMall Ecommerce: The Taobao and TMall platforms will remain wholly owned by the main company. The business will also include B2C retail, Taocaicai, Taobao Deal, and CBU. Trudy Dai, the President of Core Domestic E-commerce, will head up the Taobao Tmall Commerce Group.
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Cloud Intelligence: This will include Ali Cloud, DingTalk, TMall Genie, and DAMO Academy, and will be headed up by Daniel Zang, as mentioned above.
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Local Services: Includes of Amap (maps, e-hailing, and express delivery) and Ele.me (to home delivery of groceries, medicine, and food) and will be headed up by Yongfu Yu.
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Cainiao Logistics: Cainiao is dedicated to meeting Alibaba Group's logistics vision of fulfilling consumer orders within 24 hours in China and within 72 hours anywhere else in the world. The business will be led by Lin Wan, who is already president of this arm.
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Global Digital Commerce: President of International Digital Commerce, Jiang Fan, will head up the business that includes Lazada, AliExpress, and ICBU.
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Digital media and Entertainment: Will include Youku, and Ali Pictures, among others. The business unit will be led by current incumbent, Luyuan Fan.
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Other investments include Alibaba's 33% stake in Ant Group.
We like this restructuring
This move is expected to unlock substantial value for investors as the company will now be valued on a "sum-of-the-parts" basis - with each business unit trading on an appropriate multiple relative to its individual prospects, instead of a valuation being attached to the whole - that may not adequately capture the growth outlook for the smaller units.
These businesses will also be able to raise funding externally - which could aid in further accelerating growth.
Competition, particularly in areas like e-commerce, has been fierce. The separate business units will be able to be more nimble in decision making, which could help gain back market share.
The possibility of separately listing these businesses could aid the market in valuing Alibaba appropriately. While a holding company discount is likely to apply, investors will be able to attach market values to the underlying businesses when valuing these stocks.
The possibility of unbundling some of these businesses to shareholders will also be value enhancing in that it will remove the holding company discount previously attached to the unbundled assets.
The investment case for Alibaba
Outside of the expected value unlock because of the business restructuring and possible corporate action going forward, we view the investment case for Alibaba as compelling.
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Alibab's digital businesses have a large addressable market - China remains the most populous country in the world and boasts an internet penetration rate of 75% and growing.
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China no longer employs a zero-Covid policy, which severely affected economic growth. The reopening of the economy is expected to reignite consumption growth as well as investment by businesses in areas like cloud.
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The regulatory environment for Chinese internet companies appears to be easing, due to pressure on the state regarding tepid economic growth and simultaneous action being taken by companies to address regulators' concerns (such as this restructuring).
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Alibaba may be a key beneficiary of a resumption of interest in China and Chinese tech by market participants.
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The company delivered a strong set of results for 3Q23 (to 31 December 2022), with bottom-line growth surpassing consensus expectations by 16%. The group continues to post robust profitability driven by positive revenue and, to a larger extent, solid cost containment efforts. Cash flow generation was robust, with cash from operations up 9% y/y (2Q23: +31%, 3Q22: -22%). Free cash flow increased 15% y/y during the period.
Risks to our view
Key downside risks include:
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Large companies such as Tencent and Baidu could pose a threat to Alibaba's Local Services business. Competition in e-commerce has also intensified both locally and internationally.
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New investments could drain on cash flow and add an element of execution risk to the name.
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Fresh regulatory clampdowns and/or administrative fines are a risk in China.
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Weak economic growth may persist in China despite the reopening. While not our base case, this could derail a recovery in the top line.
Valuation considerations
While we have seen a recovery in the Alibaba share price since the start of the year, and in response to the restructuring news, the share price remains well below its 2020 peak.
On a consolidated basis, the forward PE of 11.7 times still represents a substantial discount to peers and is well below where it has traded in the recent past.
Valuing the company on a sum of the parts basis, yields a target price well above current levels, and justifies a consolidated PE multiple well above the 2-year average.
