Ahead of Alibaba’s impending Initial Public Offering (IPO), I have read estimates valuing the company at everything ranging from $80bn to $250bn. Quite rightly, I have heard many ask why is there such a startling lack of consensus on the worth of a company that has grown to dominate the financial press. Well, this is due in part to a lack of any financial data on the company and the absence of any established industry or competitors with which to project the free cash flows required to produce a DCF. In the second part, the failure in valuing Alibaba with the data that is available has been the result of a lack of understanding of what Alibaba actually does, or, where this is understood, a failure to fully account for this in the subsequent multiple analyses. Consequently, in this article, I will go back the fundamentals underpinning any company valuation by asking what is Alibaba? Then, based on this understanding, I will use a basket of public companies that best represent Alibaba’s product offering in order to carry out an analysis. There remain shortfalls here however, and I believe that such an approach understates the growth potential of Alibaba giving our findings an inherent downward bias and thus make this our valuation’s lower bound. Consequently, I will proceed to take Yahoo!’s 24% stake in Alibaba as a proxy, giving a ceiling to the market’s current perception of the company’s value, and ultimately use these findings to address the question, what is Alibaba worth?
So, to begin, what is Alibaba? I have heard analysts say “Alibaba is like Amazon”, “Alibaba is like eBay”, “Alibaba is like Google”. Alibaba is not like Amazon, it is not like eBay and it is not like Google. Rather, it bears characteristics of all these three simultaneously. How? Well, when we speak of Alibaba we actually speak of the Alibaba Group. This constitutes a portfolio of separate companies that collectively provide a unique multi-level Internet product offering dominating the Chinese e commerce market.
I consider Amazon, eBay and Google to reflect aspects of Alibaba’s businesses as follows. Amazon, which is the market leader in the global ecommerce space, is comparable to Tmall.com. Tmall.com is Alibaba’s market-leading business-to-consumer platform and the most popular way for customers to purchase branded goods in China. Taobao.com is the most popular customer-to-customer marketplace. AliExpress is an online platform facilitating trade between small sellers and online buyers. AliPay is Alibaba’s third party online payment solution business. Taken together, these companies provide a business offering similar to that provided by eBay both through its online consumer-to-consumer and small business seller auction site and its third party, secure, online payment processing facility PayPal. Alibaba also owns China Yahoo! and Alibaba Cloud computing, providing services and advertising revenue streams similar to those of Google.
Hence, I argue that through Amazon, eBay and Google we develop an understanding of what Alibaba is, and by using their collective Price to Earnings (P/E) ratios into our subsequent analysis, provide a more representative and therefore more accurate proxy for the valuation of Alibaba than any one of these would provide on their own. I also intend to include Tencent Holdings, which competes with Alibaba for China’s ecommerce market and with Alibaba’s Laiwang via its own chat app WeChat. Finally, my calculation will also include the Internet search service Baidu, which competes with Alibaba for advertising revenues. The valuation of Alibaba using the trailing twelve month P/E multiples of Amazon, eBay, Google, Tencent and Baidu is shown in the table below.
For this analysis, I have taken the average of the P/E multiples for the trailing twelve month (ttm) period over the five aforementioned firms and multiplied this this by Alibaba’s net earnings, calculated using data from Yahoo!’s 2013 earnings report to be US$2.81bn (below). This implies a valuation of Alibaba equal to US$126.73bn.
I have reason to believe however, that this figure may understate Alibaba’s true worth. The reason for this is twofold. Firstly, no account was taken in my analysis for Alibaba’s two leading business-to-business market platforms, Alibaba.com and 1688.com. The reason for this is that there is no listed company that provides a service comparable to that offered by these businesses. Secondly, and more importantly, I do not believe that any of the multiples used reflect the profitability or growth potential of Alibaba. For example, Alibaba’s profit margin for the third quarter of 2013 was 44.59%. Over the same period Amazon’s gross profit margin was just 0.73%. Moreover, Alibaba is growing far faster that Amazon, increasing revenues by 51% year-on-year in a Chinese ecommerce market still in a relatively young growth stage. Compare this to Amazon’s 20% in the developed western market and it becomes evident that the growth potential of Alibaba is far greater than Amazon. I believe that this is similarly characteristic of at least all of the US companies included in the analysis. This is likely to have depressed our valuation of Alibaba and hence I consider US$126.73bn to be the lower bound of Alibaba’s worth.
In order to find an upper bound for our Alibaba valuation we are required to leave standard valuation techniques behind and get a little bit creative. It is possible, and I intend, to use Yahoo!’s current market value as a proxy to weigh the market’s current perception of Alibaba. This is relevant because a large number of fund managers are using Yahoo!’s 24% stake in Alibaba to synthetically invest in Alibaba ahead of its IPO. This calculation can be performed as follows.
Here, I have started with Yahoo!’s market cap and deducted from this all the items that I can measure and that I can say with certainty give Yahoo! value over and above the worth of its holding in Alibaba. Beyond these three deductions, I assume that the value of Yahoo!’s operations are worth zero (perhaps not much of an exaggeration, but that’s for a different discussion). This allows me to assert that, at its absolute maximum, Yahoo!’s 24% stake in Alibaba is worth US$26.15bn. Grossing up for tax, this values Alibaba at US$165.09bn.
So, we have a valuation for Alibaba ranging from US$126.73bn at its lower end and US$165.09 at the higher. Where do I think Alibaba will actually pitch? Unsurprisingly, somewhere in the middle, or to give it a figure, approximately US$145bn. That is not to say that this is how much the company’s IPO will fetch. IPO’s invariably price the stock at a discount. Nor is it to say that I am right, but based on the information available at this time, I’m afraid that it’s my best guess.
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