19 September 2018 United States EQUITIES Alibaba Group Holding (BABA US) BABA US Outperform Investor Day 3: It’s all about cloud Price (at 03:00, 19 Sep 2018 GMT) US$156.65 Valuation US$ 250.00 Key points - Sum of Parts 45% average CPU utilization rate of clusters, well above <5% for others. 12-month target US$ 250.00 AliCloud processed 325k transactions per second at peak. 12-month TSR % +59.6 17% reduction in IT cost per 10k transactions on Single’s Day. GICS sector Software & Services Market cap US$m 406,066 30-day avg turnover US$m 4,352.3 Event Number shares on issue m 2,592 Alibaba’s Cloud Conference kicked off in Hangzhou on September 19. In our Investment fundamentals meeting with AliCloud Chief Architect, Chief Machine Intelligent Scientist and AliCloud’s business partners, they shared insights about cloud operating Year end 31 Mar 2018A 2019E 2020E 2021E systems, artificial intelligence, blockchain-as-a-service (BAAS) and customized Revenue bn 250.3 404.0 560.4 744.8 EBIT bn 69.3 70.3 116.4 170.3 solutions for different verticals and government. Reported profit bn 64.0 56.3 97.8 144.8 Adjusted profit bn 85.8 95.6 138.2 189.3 Impact Gross cashflow bn 99.8 115.2 166.9 228.2 Apsara: the cloud operating system. Aspara provides resource CFPS Rmb 38.23 43.77 63.01 85.64 management, storage management, overlay networking and infrastructure CFPS growth % 44.0 14.5 44.0 35.9 PGCFPS x 28.1 24.6 17.1 12.6 management. It provides higher resource utilization, faster iteration and better EPS adj Rmb 32.87 36.29 52.18 71.06 security. It also processed large-scale data as a native service. Notably, EPS adj growth % 40.1 10.4 43.8 36.2 AliCloud and AWS are the only two major cloud vendors with the elastic Bare PER adj x 32.7 29.6 20.6 15.1 Metal offering. AliCloud X-Dragon server, launched a month before AWS Nitro, Total DPS Rmb 0.00 0.00 0.00 0.00 has better functionality: Total div yield % 0.0 0.0 0.0 0.0 ROA % 14.9 13.8 16.4 18.4 ROE % 27.1 24.2 28.3 30.2 Alicloud vs AWS server comparison EV/EBITDA x 30.7 28.7 18.1 12.7 Net debt/equity % -16.8 -22.9 -26.4 -33.8 X-Dragon (with Elastic Bare AWS Nitro P/BV x 7.7 6.5 5.1 4.0 Metal offering) BABA US vs S&P 500, & rec history Public Beta Date Oct 2017 Nov 2017 General Availability Date Mar 2018 May 2018 Block Device Throughput 300 thousand IOPS 80 thousand IOPS Networking Throughput 5 million pps 2 million pps Source: Company data, Macquarie Research, September 2018 Alibaba Damo Academy focuses on fundamental research in five areas: machine learning, data computing, robot, financial technology and X (frontier projects). Since its establishment a year ago, Damo has 300 researchers in eight cities from Beijing to Sunnyvale. Alibaba also announced that it will merge the chip team from Damo Academy and microship maker C-Sky to Note: Recommendation timeline - if not a continuous line, then there was no establish a dedicated chip subsidiary named Pingtouge Semiconductors Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, September 2018 Company. Main products in the future include AI chips and quantum chips. (all figures in Rmb unless noted, TP in USD) Advertiser segmentation will bring more monetisation opportunities in Analysts the long term. The company reiterated in the Q&A session today that 70% of their new users came from lower-tier cities. With more targeted ads, Tmall Macquarie Capital Limited Wendy Huang, CFA +852 3922 3378 brands can spend more on marketing higher-tier city users while Taobao small [email protected] merchants can target lower-tier city users. Ellie Jiang +852 3922 4110 Earnings and target price revision [email protected] No change. Marcus Yang +86 21 2412 9087 [email protected] Price catalyst John Wang +852 3922 3578 12-month price target: US$250.00 based on a Sum of Parts methodology. [email protected] Catalyst: 2QFY19 results in November 2018. Frank Chen +852 3922 1433 [email protected] Action and recommendation Maintain OP. Please refer to page 6 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. Macquarie Research Alibaba Group Holding (BABA US) Fig 1 Alibaba Group Holdings – SOTP valuation (FY19E) Adjusted Adjusted Revenue Revenue EBITA EBITA Valuation Valuation (RMB bn) CAGR 19-22E margin (RMB bn) EV/EBITA P/S (RMB bn) (US$ bn) Core commerce (including Cainiao) 346 30% 44% 152.26 18 8 2,741 403 Cloud computing 25 66% -3% na 42 1,063 156 Digital media and entertainment 28 21% -35% na 2 56 8 (Youku, UCWeb, Alisports, Ali Music, Tmall TV) Innovation initiatives and others 5 9% -50% na 2 9.87 1 (YunOS, AutoNavi, DingTalk) Ant Financial (33% of US$150bn) 50 Major minority investments* 18 Net cash 17 Total 654 Per share (US$) 250 *Note: Major minority investments include Weibo, Didi Chuxing, Koubei, Alibaba Picture, Momo, Meituan, and Sun Art. Source: Company data, Macquarie Research, September 2018 Fig 2 Alibaba cloud computing revenue RMB m 5,000 200% 4,500 175% 180% 4,000 156% 160% 3,500 140% 128% 130% 126% 104% 3,000 115% 99% 120% 96% 103% 2,500 85% 106% 93% 100% 103% 2,000 82% 80% 1,500 60% 50% 1,000 36% 40% 500 20% - 0% Cloup computing revenue yoy growth Source: Company data, Macquarie Research, September 2018 19 September 2018 2 Macquarie Research Alibaba Group Holding (BABA US) Fig 3 Alibaba Group Holdings – Financials YE March 31 FY16 FY17 FY18 FY19E FY20E FY21E 18–19E 19E–20E 20E–23E Consolidated income statement (Rmb mn) Gross revenue 101,143 158,273 250,266 404,017 560,391 744,762 61% 39% 26% Cost of services (34,355) (59,483) (107,044) (209,843) (281,464) (377,755) 96% 34% 27% Gross profit 66,788 98,790 143,222 194,174 278,927 367,007 36% 44% 26% GP margin 66% 62% 57% 48% 50% 49% (917 bps) 171 bps (37 bps) SG&A (37,686) (50,735) (73,908) (123,874) (162,513) (196,666) 68% 31% 20% Operating profit 29,102 48,055 69,314 70,300 116,415 170,340 1% 66% 33% OP margin 29% 30% 28% 17% 21% 23% (1030 bps) 337 bps 368 bps Pre-tax income 81,468 60,029 100,403 78,958 127,523 186,588 -21% 62% 34% Income taxes (Credit) (8,449) (13,776) (18,199) (26,787) (36,278) (50,522) 47% 35% 31% Net income 71,289 41,226 61,412 53,257 94,144 140,359 -13% 77% 35% Non-GAAP net income 42,833 60,317 85,766 101,656 138,185 189,324 19% 36% 30% Non-GAAP EBITDA 51,885 74,456 105,955 128,938 176,832 243,656 22% 37% 30% Non-GAAP EBITDA margin 51% 47% 42% 32% 32% 33% (1042 bps) (36 bps) 305 bps Balance Sheet (Rmb mn) Current Assets 134,070 181,864 256,855 330,404 408,846 547,204 29% 24% 32% Cash and cash equivalents 106,818 143,736 199,309 242,868 290,792 393,233 22% 20% 34% Short-term investments 4,700 3,011 6,086 6,390 6,710 7,045 5% 5% 5% Restricted cash and escrow 1,346 2,655 3,417 3,588 3,767 3,956 5% 5% 5% receivables Prepayment, receivables and 21,206 32,462 48,043 77,558 107,577 142,970 61% 39% 26% other assets Fixed asset 230,380 324,948 460,269 538,552 631,557 742,274 17% 17% 17% Investment in equity investees 91,461 120,368 139,700 160,655 184,753 212,466 15% 15% 15% Investment securities 29,392 31,452 38,192 42,011 46,212 50,834 10% 10% 10% Prepayments, receivables and 6,007 8,703 16,897 18,587 20,445 22,490 10% 10% 10% other assets PP&E 13,629 20,206 66,489 106,608 160,656 230,378 60% 51% 37% Land use rights 2,876 4,691 9,377 9,377 9,377 9,377 0% 0% 0% Intangible assets 5,370 14,108 27,465 39,165 47,964 54,580 43% 22% 10% Goodwill 81,645 125,420 162,149 162,149 162,149 162,149 0% 0% 0% Total asset 364,450 506,812 717,124 868,956 1,040,403 1,289,478 21% 20% 23% Current Liabilities 52,039 93,564 135,810 215,709 272,468 355,990 59% 26% 25% Current bank and secured 4,304 5,948 6,028 6,028 6,028 6,028 0% 0% 0% borrowings Accrued expenses, accounts 27,334 46,979 81,165 159,111 213,417 286,429 96% 34% 27% payable and other liabilities Other payables and merchant 9,814 25,297 26,043 26,043 26,043 33,856 0% 0% 30% deposits Deferred revenue and customer 10,297 15,052 22,297 24,527 26,979 29,677 10% 10% 10% advances Non-current liabilities 62,522 89,127 141,875 141,875 141,875 141,875 0% 0% 0% Redeemable Preference 51,596 45,876 85,372 85,372 85,372 85,372 0% 0% 0% Shares/unsecured senior notes Non-current bank borrowings 1,871 30,959 34,153 34,153 34,153 34,153 0% 0% 0% Other non-current liabilities 9,055 12,292 22,350 22,350 22,350 22,350 0% 0% 0% Total liabilities 114,561 182,691 277,685 357,584 414,343 497,865 29% 16% 18% Total mezzanine equity 350 2,992 3,001 3,001 3,001 3,001 0% 0% 0% Capital 131,319 161,139 184,171 202,847 223,391 248,584 10% 10% 10% Reserves and others 6,916 9,102 9,298 9,298 9,298 9,298 0% 0% 0% Retained earnings (Accumulated 78,752 108,558 172,353 225,610 319,754 460,113 31% 42% 41% deficits) Total liabilities, mezzanine 364,450 506,812 717,124 868,956 1,040,403 1,289,478 21% 20% 23% equity and equity Cashflow statement (RMB mn) Operating cash flow 56,836 80,326 125,171 126,202 152,803 231,280 1% 21% 32% Net income (loss) 71,289 41,226 61,412 53,257 94,144 140,359 -13% 77% 35% Depreciation and Amortisation 6,701 10,406 16,566 22,760 32,418 43,315 37% 42% 29% Change in net working capital 18,727 30,651 22,840 50,185 26,241 47,606 120% -48% 27% Investing cash flow (42,831) (78,364) (83,890) (101,043) (125,422) (154,032) 20% 24% 20% Capex (10,845) (17,539) (33,106) (53,445) (74,130) (98,520) 61% 39% 26% Purchase of intangible assets (5,407) (13,860) (21,134) (21,134) (21,134) (21,134) 0% 0% 0% Others (26,579) (46,965) (29,650) (26,464) (30,158) (34,379) -11% 14% 14% Financing cash flow (15,846) 32,914 20,359