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Alibaba Group Holding Ltd. OUTPERFORM 12-18 Mo EQUITY RESEARCH COMPANY UPDATE July 6, 2016 INTERNET Stock Rating: Alibaba Group Holding Ltd. OUTPERFORM 12-18 mo. Price Target $110.00 Increase PT to $110 on Business Outlook and SOTP BABA - NYSE $78.64 SUMMARY We have become more constructive on BABA, walking away from its Investor 3-5 Yr. EPS Gr. Rate 30% Day. In addition to high-level takeaways in our First Look, this note focuses on 52-Wk Range $86.42-$57.20 addressing major misunderstandings around the company that overhang the stock's Shares Outstanding 2,562.0M valuation. These include: non-core investments, accounting quality and counterfeiting Float 1,090.0M controversy. We also believe the AliCloud flywheel will trigger a revaluation of BABA Market Capitalization $196,228.6M similar to AMZN in 2015, while the Street seems to be massively underestimating Avg. Daily Trading Volume 15,058,767 AliCloud's growth potential. Increasing FY17/18E revenue by 5%/7% on higher Dividend/Div Yield NA/NM take-rate/AliCloud estimates, but reducing non-GAAP net income by 3%/4%, on Book Value $13.10 currency and YOKU/LAZADA consolidation. Our sum-of-the-parts analysis suggests Fiscal Year Ends Mar a $282B fair value for BABA, including $238B for marketplace/AliCloud and $44B for investments. Increasing PT to $110 from $100. Reiterate Outperform. 2017E ROE 12.3 % LT Debt $8,292.0M KEY POINTS Preferred NA ■ Investors are "ignoring" the value of Ant Financial (AFG). BABA (ex. AFG) Common Equity $38,700M is trading at 17x 2-yr P/E vs. 30%+ CAGR. Investors remain uncertain about Convertible Available Yes AFG's value and whether they can benefit from owning BABA. However, we think EPS Non- the 2014 Share and Asset Purchase Agreement (SAPA) is highly aligned with Q1 Q2 Q3 Q4 Year Mult. GAAP investors’ interests, and BABA’s share is the best proxy to participate in China’s 2015A 0.49 0.45 0.81 0.48 2.25 35.0x Internet finance industry. 2016A 0.59 0.57 0.99 0.47 2.63 29.9x ■ Investors don't like Cainiao, as its business model is widely misunderstood. 2017E 0.61 0.69 1.18 0.60 3.08 25.5x We highlight Cainiao's asset-light nature and believe the company is leveraging an Prior (E) 0.62 0.67 1.17 0.72 3.18 NM efficient model to address a massive, fragmented, but underdeveloped industry. 2018E -- -- -- -- 4.27 18.4x Prior (E) -- -- -- -- 4.44 NM Our analysis suggests substantial growth opportunities, while margin pressure will Revenue be alleviated as Cainiao scales on 3P business. Q1 Q2 Q3 Q4 Year Mult. ($/mil) ■ AliCloud massively underestimated, in our view. China's Cloud industry is on 2015A 2.5B 2.7B 4.2B 2.8B 12.3B 15.7x the brink of massive growth, with AliCloud best positioned. In addition to AliCloud's 2016A 3.3B 3.5B 5.3B 3.8B 15.9B 12.1x leadership in infrastructure, middleware/security/pricing are differentiators that 2017E 4.5B 5.1B 7.6B 5.4B 22.6B 8.5x should drive share gains globally. We expect Cloud revenue to grow 112% Prior (E) 4.3B 4.8B 7.2B 5.1B 21.4B NM annually vs. Street's 82%, reaching 18% of FY20E revenue vs. FY16's 3%. 2018E -- -- -- -- 30.5B 6.3x Prior (E) -- -- -- -- 28.5B NM ■ Our SOTP valuation suggests a $282B fair value for BABA, or $110 per share. This includes 1) $232B pretax value for the core marketplace, 2) $43B pretax value for AliCloud, 3) $21B for the stake in AFG, 4) $3.7B for Cainiao ownership, 5) $18.7B for long-term investments and 6) ($44.9B) corporate tax. This valuation implies 16x/26x our FY18E non-GAAP EBITDA/EPS. ■ Estimate revisions. Increasing FY17/18 revenue estimates by 5%/7% to reflect the evolving ecosystem that drives take-rate. However, we are maintaining FY17E gross profit. Raising FY18E by 4% on GM pressure from YOKU/LAZADA consolidation. Lowering FY17E non-GAAP EBIT by 4%, modeling higher capex/ D&A for AliCloud. GMV estimates are unchanged. Stock Price Performance Company Description Alibaba is the largest online and mobile commerce company in the world, as measured by GMV. It also provides cloud computing services and partners with third-party service providers to offer Jason Helfstein Jed Kelly, CFA payment and escrow, financing and 212-667-6433 212-667-8196 logistics services. [email protected] [email protected] Bo Pang Kevin Gallagher 212 667-7935 212 667-7598 For analyst certification and important disclosures, see the Disclosure Appendix. [email protected] [email protected] Oppenheimer & Co Inc. 85 Broad Street, New York, NY 10004 Tel: 800-221-5588 Fax: 212-667-8229 Alibaba Group Holding Ltd. BABA (OUTPERFORM) - $110.00 5-YEAR PRICE PERFORMANCE INVESTMENT THESIS 140 Alibaba is the largest online and mobile commerce company in the world as measured by gross merchandise volume, or 120 GMV. Alibaba has also been building up one of the most 100 comprehensive business ecosystems in the world, covering 80 a wide range of business offerings, which altogether create compelling network effects. Our positive thesis is based on the 60 company's unrivaled dominant position in its core business, its BABA 40 pioneer ecosystem that creates a long-standing barrier to entry, Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 and numerous drivers, including enhancing monetization and Source: Bloomberg solid GMV growth outlook, as well as new growth opportunities including cross-border e-commerce. BASE CASE ASSUMPTION CATALYSTS ■ GMV CAGR of 17% FY16-20E ■ GMV growth acceleration in CY16 ■ Revenue CAGR of 35% FY16-20E ■ Evidence of macro turnaround ■ Blended take-rate increases from 2.59% in FY16 to 3.69% in FY20E ■ Faster than expected monetization improvement ■ Non-GAAP EBITDA margin declines from 51.7% in FY16 to 47.9% ■ Evidence of successful integration of investees, reflecting as higher in FY20E ARPU ■ Non-GAAP EPADS CAGR of 30% FY16-20E ■ Exponential growth of Cloud revenue ■ Higher governance transparency and incremental disclosure regarding core businesses and major investees. ■ Ant Financial's IPO ahead of schedule (YE2016), with higher than expected valuation. ■ Negative results from SEC inquiry UPSIDE SCENARIO DOWNSIDE SCENARIO ■ Evolving business environment and advanced big data technology ■ Macro slowdown further pressures GMV growth and drives could provide SMEs a higher ROI advertising solution, which significant devaluation of local currency translates into improving monetization capabilities. ■ BABA continues to lose market share to competitors due to ■ Further gain share in B2C, leveraging capacities of its investees. disadvantages in services and product authenticity ■ Penetration in lower tier cities could underpin BABA's LT GMV growth ■ Negative results from SEC inquiry ■ Faster than expected adoption of AliYun might become BABA's LT ■ Less transparency on corporate governance and lower accounting revenue driver quality ■ Increasing valuation of major investees, primarily Ant Financial and ■ Insufficient disclosure on key operating metrics and major investees Cainiao Network PRICE TARGET CALCULATION Our $110 price target (was $100) suggests 40% upside from the current levels. This is based on our five-bracket SOTP valuation. In detail, the $282B fair value includes 1) $232B pretax value for core marketplace business, 2) $43B pretax value for AliCloud, 3) $21B for stake in AFG, 4) $3.7B for Cainiao ownership, 5) $18.7B for long-term investment and 6) ($44.9B) corporate tax. This valuation implies 16x/26x our FY18E non-GAAP EBITDA/EPS. KEY RISKS ■ Fierce competition among various rivals may hurt growth trajectory; ■ Aggressive investments and acquisitions pose uncertainties; ■ Risk associated with the partnership corporate structure—interests of the partnership may not align with those of Alibaba’s public shareholders; ■ Reliance on third-party merchants leads to challenges in quality and efficiency of services; ■ Potential taxation on C2C e-commerce may hurt Taobao’s business; ■ Insufficient disclosure on key operating metrics and major investees; ■ Negative results from SEC inquiry; ■ Further economic slowdown and consumption weakness. Jason Helfstein: 212-667-6433 2 BABA (OUTPERFORM) - $110.00 Alibaba Group Holding Ltd. Table of Contents Discussing Investors’ Major Concerns ............................................................. 4 Concern 1 – Ant Financial Group .................................................................. 4 Company Profile ........................................................................................... 4 Ownership Structure..................................................................................... 4 Agreement with BABA .................................................................................. 5 Takeaways from the Investor Day ................................................................ 5 Financials and Valuation .............................................................................. 6 Concern 2 – Cainiao Network ........................................................................ 8 Company Profile ........................................................................................... 8 Revenue Model ............................................................................................ 9 Evidence of Asset-light Business Model ....................................................... 9 Business Opportunities .............................................................................. 10 Takeaways from Suzhou Tmall Supermarket Warehouse Tour ................. 10 Conflict of Interest, a Potential Threat ........................................................ 11 Related-party Transactions .......................................................................
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