August 23, 2018

Breakingviews: Alibaba channels old-school conglomerates

by Breakingviews.

Alibaba is channelling old-school conglomerates. Quarterly revenue at the Chinese e-commerce giant is soaring, but earnings were flat compared to a year ago. That’s largely due to boss Jack Ma’s forays in cloud computing, supermarkets, video streaming and other bets. As with sprawling industrial companies of yore, Alibaba’s unwieldy mix of businesses may merit a valuation discount.

Sales in the three months to June hit 81 billion yuan ($11.8 billion), up a breakneck 61 percent from a year earlier. The strong growth comes mostly from Alibaba’s online retail division, which includes the company’s flagship Taobao and Tmall shopping sites in the People’s Republic, as well as its Southeast Asia subsidiary, Lazada. Other units, while much smaller, also delivered: revenue from cloud computing, for example, nearly doubled in the quarter.

Yet heavy investments in traditional retail – department stores, shopping malls, supermarkets and logistics – have squeezed profitability at its main e-commerce business. The margin based on adjusted earnings before interest, tax and amortization of Alibaba’s core operations tumbled to 47 percent in the recent three-month period, from 63 percent a year earlier. After backing out some 11 billion yuan in share-based compensation and other one-offs, adjusted earnings didn’t really change. The company blames a decrease in profits from its payments and financial-technology affiliate, Ant Financial, which Alibaba has a profit-sharing agreement with, as well as currency-exchange losses.

Alibaba’s diversification into things like cloud computing is a bit like that of U.S. peer Amazon. But the breadth of Alibaba’s businesses and investments almost looks like a traditional conglomerate – think GE, which has been gradually dismantling itself under boss John Flannery. It makes sense for Ma to spread his wings as growth in China slows, but it is getting difficult to justify how combining all of Alibaba’s investments creates a better business. The $461 billion company is already opaque and complex to outsiders. It doesn’t justify its investments on financial grounds, and sometimes not even on strategic grounds.

Shares of Alibaba currently trade more than one-fifth below the average target price of analysts polled by Eikon. That gap is well above the two-year discount average of 13 percent. Is that undervaluation? It might better be called a conglomerate discount.

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