Alibaba Group Holding Ltd. (BABA, Financial) has been one of the most followed Chinese American depositary receipts since its initial public offering in the U.S. Interests in the stock rose even more after value investing legend Charlie Munger (Trades, Portfolio) used leverage and bought a big position in the stock. The bull’s case is that valuation is cheap and Alibaba’s core business has stabilized, especially after its "1 6 N" governance restructure and the return of co-founder and Jack Ma’s right-hand man Joseph Tsai as chairman of the group.
The bull case is flawed because it fails to address the core issues Alibaba faces, namely the bureaucratic culture and the company's narrowing moat. The bear case is mostly regarding China’s macroeconomic, regulatory and geopolitical risks. While the bear case addresses the valuation concern, it is generic across all Chinese ADRs and fails to address company-specific risks.
Alibaba's journey since 2014
I have followed Alibaba since 2014. Back then, the company was invincible in e-commerce and payment, and its cloud business was booming. In hindsight, Alibaba’s turning point came in 2015 and 2016 when PDD Holdings Inc. (PDD, Financial) and Bytedance were founded. Then, in 2020, when Ma made a big mistake by criticizing China’s financial system, the fall of the Alibaba empire accelerated.
After years of mismanagement and increased competition from PDD, Bytedance and Meituan, Alibaba looks like a sinking ship now. Therefore, while its stock looks cheap from a valuation standpoint, I would rather stand on the sideline until things become clearer.
Shrinking e-commerce market share
Alibaba dominated China's e-commerce market prior to 2017 with market share peaking at around 80% in 2016. Since then, its market share has gradually declined. This chart below shows the extent of the decline.
Source: iResearch,author's estimate
Competition from PDD, Bytedance and Kuaishou
It is quite extraordinary that within only a few years, PDD Holdings, Bytedance and Kuaishou have taken more than 30% of Alibaba's market share. It is likely that PDD will continue to take share from Alibaba.
Beside PDD, Douyin (Bytedance) and Kuaishou also took a big chunk of Alibaba's market share. These two companies dominated China's short-form video and live-streaming industry. Douyin and Kuaishou's business model is also different from Taobao and T-Mall's business model. Using an advertising analogy, Taobao and T-Mall are more like Alphabet's (GOOG, Financial) Google because consumers have high intention when they search for an item, whereas Douyin and Kuaishou are similar to TV and website ads, which mostly generate impulsive sales.
Alibaba's struggle with live-streaming platforms
To be fair, Alibaba has fought hard with the live-streaming platforms. Both Taobao and T-Mall have live-streaming businesses. But again, Douyin's business model is differentiated and superior to Alibaba's business model in two important ways.
First of all, Alibaba, especially its Taobao business, relies heavily on top live-streamers, whereas Douyin intentionally tries to avoid over-reliance on top live-streamers. This difference made Alibaba much more susceptible to risks associated with its top live-streamers. When Taobao's top live-streamer, Viya, was hit with a massive fine due to tax evasion, it was a big blow to Alibaba.
Second, Douyin and Kuaishou, at their cores, are content businesses. Their high-quality short videos attract more traffic to the platforms as more and more Chinese spend more time watching them. This key difference gives Douyin and Kuaishou's a natural advantage in terms of traffic costs, especially in the health and beauty category, which Taobao and T-Mall dominate.
Therefore, it is likely Douyin and Kuaishou will also continue to take share from Alibaba.
Alibaba's structural problem
From the above analysis, it is clear Alibaba's problem with its core e-commerce business is structural and deep-rooted. Unless the company takes a drastic approach and completely overhauls its Taobao and T-Mall business, it is very hard to imagine how it can turn them around.
Cloud headwinds continue
Alibaba's cloud business was once considered to be the next big growth engine for the company. As we can see from the following table, before fiscal year 2022, it was growing very rapidly. But after 2022, the growth rate sharply decelerated.
Source: BABA's annual reports
As such, it appears Alibaba's cloud business faces a few headwinds.
First is an industry headwind. Most of Alibaba Cloud's biggest customers are from the internet industry. The internet industry has the highest penetration rate of cloud services, especially public cloud. With the crackdown on the tech industry and a weak economy, the demand for cloud services from the internet industry fell sharply. And a declining demand and oversupply resulted in intense pricing war. In the second quarter of 2023, Alibaba announced a price cut of 15% to 20% for some of its cloud computing services, while Tencent (HKSE:00700, Financial) made an even more dramatic price cut, lowering the price some of its cloud computer services by as much as 40%.
Second, its government and enterprise clients are shifting preference to SOE cloud service providers. Due to national security concerns, most government and some government-related organizations have moved from private cloud providers such as Alibaba Cloud to SOE cloud service providers such as China Mobile Cloud, China Tel’s Tianyi Cloud and Unicom Cloud. This trend is almost certain to be irreversible.
The third headwind is the loss of key overseas customers. In the fourth quarter of 2021, Alibaba’s largest cloud business customer, Bytedance, terminated its overseas (TikTok) cloud contract. The loss of TikTok’s business had a big impact on the company revenue of 3.55 billion yuan ($485.55 million) for fiscal 2022 and 255 million yuan for the fourth quarter of 2023. Although this is expected to gradually decrease in the future, it is a big blow to Alibaba’s overseas expansion plan.
Of Alibaba Cloud’s three biggest headwinds, only the industry headwind is cyclical, while the other two challenges are structural. Therefore, it looks like the best days for Alibaba’s cloud business are behind.
Alibaba’s cultural crisis
Over the past nine years, I have witnessed Alibaba’s growth. In 2014, it was an inspirational organization full of energy, dreams and confidence. But today, Alibaba looks like an old, incompetent man ready to retire into the sunset. Almost every big organization becomes bureaucratic at some point. Alibaba is no exception.
But Alibaba’s culture problem is much more than just being bureaucratic. Since Ma passed the baton to Daniel Zhang, fewer and fewer employees still believe in Ma’s vision, and there are constant internal fights among the partners and top management team. To some extent, Alibaba is facing a cultural crisis. This is one of the reasons why Tsai returned as Alibaba’s chairman. Tsai is a very capable manager, but given his age and facing multiple formidable and younger competitors, I do not know if there is much he can do to turn around the morale and culture.
Valuation
Alibaba posted strong first-quarter 2024 results. Consensus earnings per share estimates for the year is about $9 per ADR, representing seemingly strong 16% year-over-year growth. Estimates for fiscal 2024 and 2025 are also fairly robust at 10% and 13.5%.
However, most of the earnings growth probably will come from massive layoffs and other efficiency measures, not from growth of core business. In the longer term, Alibaba's earnings may actually decline. Therefore, it is not practical to put a reasonable multiple to the business in my opinion. Even though Alibaba looks cheap at the moment, the intrinsic value of the business may decline over time. But given the valuation level, I would not short the stock either.
Summary
While Alibaba is still a very strong business in many aspects, it faces competitive threats in two of its most important businesses, namely e-commerce and cloud. The moat of the business has been narrowing and there is no clear sign of reversing this trend. Alibaba is also facing a cultural crisis that may or may not be resolved by the return of Tsai. Even though valuation looks cheap, it is better to stay on the sidelines.
