Is Alibaba Undervalued?

Beating Warren Buffett

The Alibaba Story

My Recommendation for Alibaba

Alibaba Group Holding Ltd. (NYSE Symbol: BABA) operates mostly in the People’s Republic of China from its headquarters in Hangzhou. The company offers a mix of online retail and payment services, a search engine, banking, software, mobile services, e-learning, microblogging, video streaming and cloud computing services.

Last year, Alibaba handled more sales than eBay and combined. The company is as a platform for third parties, making it more like eBay than Amazon. Alibaba’s prospectus states, “We do not engage in direct sales, compete with our merchants, or hold inventory.”

The group began in 1999 when English teacher Jack Ma founded the website, a business-to-business portal to connect Chinese manufacturers with overseas buyers. Alibaba’s consumer-to-consumer portal Taobao, similar to eBay, features nearly a billion products and is one of the 20 most-visited websites globally. Alibaba’s various sites account for over 60% of parcel deliveries in China.

The company’s online payment service Alipay, comparable to PayPal, accounts for roughly half of all online payment transactions within China. The vast majority of these payments occur using Alibaba services. In 2013, Alibaba controlled 80% of China’s online shopping market, a huge market that is expected to grow from $295 billion in 2013 to $713 billion in 2017.

Where’s the profit?

Many companies go public as soon as minimal profits begin to appear. Alibaba, though, is well established and earns more than, eBay, Facebook or Twitter. In the quarter ended June 30, Alibaba’s earnings exceeded $1 billion on revenue of $2.5 billion. That’s in just three months! Alibaba’s net profit margin of 40% is significantly higher than eBay, Amazon or even Google.

How fast will sales and earnings grow?
Online retail sales are expected to increase 30% per year during the next three years in China. Alibaba’s sales will likely advance 28% to 30% during the next three to five years. EPS (earnings per share) will surge at a similar pace during the same period. For the 12 months ending March 31, 2015, EPS will hit $2.25, then $2.92 for the following 12 months ending March 31, 2016, and $3.74 in the next 12 months.

Is Alibaba undervalued?

Allibaba will go public on the New York Stock Exchange on Friday, September 19, at an offering price between 66 and 68 per share. You probably won’t be able to buy shares at the offering price before Friday because institutional investors will likely gobble up all the shares, but you and I can buy BABA shares after the stock opens for trading on Friday.

Alibaba is the hottest deal of the year, so BABA will likely open on Friday at a higher price, possibly as high as 75. Using my EPS estimates and a presumed price of 75 on Friday, Alibaba will sell at 33 times my $2.25 forecast for 3/31/15 earnings, and 26 times my $2.92 forecast for 3/31/16 earnings. That’s about a 10% discount to fellow Chinese competitors Baidu (BIDU) and Tencent (TCEHY).

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My conclusion is that Alibaba shares are a reasonable bargain at 75 or below. Alibaba has underpriced its offering to avoid any repeat of Facebook’s disastrous initial public offering in 2012. In addition, U.S. investors still lack confidence in Chinese accounting oversight, and indeed, Alibaba reported a slight misstep in its accounting earlier this year.

The combination of high growth, a huge market opportunity and strong profitability has created an excellent buying opportunity for investors willing to take a chance on sustained long-term growth at a reasonable price.

Until next time, be kind and friendly to everyone you meet.

And don’t forget to follow me on Twitter. I’m “@J_Royden_Ward” and I send out at least one informative tweet every day!


J. Royden Ward

Chief Analyst, Cabot Benjamin Graham Value Investor

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The Alibaba IPO


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