Alibaba Group:Buy,Targeted spending to increase scale

Investing to gain further scale. For FY18, Alibaba is focused on gaining marketshare in Tmall, its B2C marketplace. In FY1Q, Tmall GMV grew 49% y-o-y, fasterthan its largest competitor, JD.com (JD US, USD39, Buy). Alibaba spent RMB4.5bnall-in on sales & marketing expenses in FY181Q, 21% vs JD.com’s RMB3.7bn. Givenits size and scale, Alibaba is under-spending its competitor, and we expect this figureto ramp up, reaching RMB25bn in FY18. Alongside its marketing initiatives, Alibabawill take control of its Cainiao Smart Logistics Network in October, investingUSD15bn over 5 years in data technology, smart warehousing and delivery, aiming todeliver orders in China within 24 hours and around the globe within 72 hours. Further,it is investing in other key strategic assets, Intime (new retail), Lazada (ASEANexpansion), and Tmall Supermarket (daily, fresh food and FMCG needs of shoppers).

    Fine-tuning estimates. We adjust our model to reflect lower gross and EBITAmargins. In particular, cost of sales will likely increase to account for its acquisitionsof Intime and Lazada, as well as costs associated with Tmall Supermarket (logistics).

    Alibaba will step up branding and couponing spending this year, reflecting its goal ofgaining share in the B2C market. For FY18, we cut our gross margin estimates by314bps to 59% and our EBITDA margin estimates by 434bps to 42%. We now seetotal revenue growing 49%, EBITA of RMB92bn and EPS of USD4.50 for FY18. Weexpect FY2Q18 total revenue to grow 53% (in line with previous estimate) but with alower EBITDA margin of 40% (was 45%). We hence cut adjusted EPS to USD0.97from USD1.07. Our FY2Q18 revenue/EPS estimates are 1% above/6% belowconsensus, while for FY18e we are in line on revenues and 9% below on EPS.

    Valuation methodology. We continue to use SOTP. Before, our SOTP approachwas to use a DCF for Alibaba and to sum the values of Ant Financial, investmentsand net cash. We now disaggregate Alibaba into its segments: Core Commerce,Cloud Computing, Digital Media and Entertainment and Innovation Initiatives andOthers. This additional granularity more accurately reflects the market valuations ofAlibaba’s business segments relative to its internet peers. We value Core Commerceat 18x FY2019e EBITA and other segments at 5x FY2019e, consistent with Alibaba’slarge cap peers. This yields a target price of USD204 (vs USD184 previously).

    Maintain Buy: our thesis rests on three points. First, Alibaba has valuable dataassets on its consumers that it can leverage to increase value to both its brands andbuyers, resulting in high monetization and margins. Second, it is the thought leader inChina retail and its New Retail concept sets the stage for long-term value creation.

    Third, valuation is attractive, trading at 25x our revised FY19 EPS versus 3-year EPSCAGR of 43%, and we see upside from its 33% equity option in Ant Financial.