Ant Group "goes ashore", Zhang Yong "goes to the cloud", how far is Alibaba from revaluation?

In the previous report released by Alibaba Deep, Dolphin Analyst discussed the current situation and possible outcomes of the e-commerce endgame between Douyin and Alibaba. The Dolphin Analyst believes that Douyin's erosion of Alibaba through the live-streaming e-commerce model will marginally decrease and will probably disappear after 2024. The biggest variable in the future is whether Douyin and Kuaishou can ultimately succeed in the traditional shelf e-commerce model.

In this article, Dolphin Analyst will focus on two other valuable assets in Alibaba Group: cloud services and payment finance (Ant Group), and explore their future growth trends. Finally, we will estimate the performance and valuation of Alibaba's three core assets and give a reasonable valuation range for Alibaba Group. The key conclusions are as follows:

1. For the cloud service sector of the second curve, the extremely poor growth performance in 2022 is mainly due to the high proportion of internet companies in Alibaba's customer structure, and 2022 happens to be the year of contraction for the internet industry. Therefore, next year, with the economic recovery and the restart of private investment, and Alibaba Cloud has significantly reduced its dependence on internet companies, the growth of cloud services will significantly recover. However, when the growth of the cloud services of the three major BAT companies has declined sharply, the cloud businesses of the three major domestic telecommunications operators have exceeded 100% in growth rate and have already occupied half of the country's cloud business market share in absolute increment. Moreover, the space for governments, enterprises, and traditional industries to move to the cloud is higher than that of internet and technology private enterprises that moved to the cloud earlier, but at the same time, in the midterm, the state-owned operators with the background of national assets are expected to continue to seize market share in the cloud service industry.

2. As an off-balance-sheet business for Alibaba, Ant Group's imagination space, especially in loans (financing business), has been suppressed by two aspects after strong rectification:

a. The growth logic of loan volume follows the capital increase speed, rather than the inherent growth potential of the business. But in the long-term perspective, the market concentration rate should still be guaranteed, and this part of the problem is not particularly significant.

b. The key is that the change in the business model after rectification has resulted in damage to the revenue and profit prospects of loans: From essentially earning the interest differential to a model of traffic fees + cloud service fees, the ability to earn interest differentials has roughly decreased from 8-10% to about 5-7%.

Based on the information above, based on the 1.8 trillion yuan given by Dolphin Analyst based on the DCF model when it went public and roughly discounted by 60%, the corresponding valuation is about 9.35 billion US dollars. Based on the 33% equity ratio, Ant Group's valuation contribution to Alibaba is about 30 billion US dollars, and the single share contribution is only 9 yuan. Ant Group's contribution to Alibaba's valuation is not significant, the key is the regulatory attitude behind it.

1. Based on our expected central growth rate of 11% for the online retail market and the gradually diminishing erosion of Alibaba by live-streaming e-commerce, Dolphin Analyst predicts that Alibaba's GMV growth rate will rebound from 2023 and stabilize at around 6%.

At the same time, to verify whether the annual growth increments of the online retail market can actually meet the growth needs of various e-commerce platforms, Dolphin Analyst has predicted the annual GMV increment needs of traditional e-commerce, live-streaming e-commerce, and Tencent Video Number, and found that the market increments can meet the needs of each player. And assuming Douyin cannot make shelf e-commerce, by 2025, each player may not even be able to completely consume the increment, which means that the e-commerce landscape may undergo a new change, and Alibaba may also have the opportunity to stop its market share from declining and rebounding.

1. Finally, based on the prediction of Alibaba's three core businesses, Dolphin Analyst used the SOTP valuation method to calculate Alibaba's reasonable valuation under different scenarios:

a. First, in an extremely pessimistic scenario, considering only Alibaba's core platform retail business and not valuing any other assets, with a net profit of $24.3 billion and a 10x PE valuation for the retail platform in 2024, the estimated valuation is $83 per share, which is Alibaba's safety line valuation.

b. In a market-neutral sentiment, we take the core platform retail ($83 per share) + the second growth curve cloud business ($19 per share) + the most valuable ant group among the core assets of the company ($9 per share) + the company's net cash as the company and valuation anchor ($17 per share). Alibaba's neutral valuation is $128 per share.

c. When the market sentiment is exuberant, we also value the company's various incidental businesses, such as Cainiao, new retail, and international retail. The estimated optimistic value of Alibaba is $153 per share. However, this scenario will only occur when the market sentiment is relatively optimistic or Alibaba begins to split its assets and go public to release value.

1. Besides e-commerce, what other focus points does Alibaba have?

Originally, aside from its e-commerce business, the Alibaba Group had two other gems, Alibaba Cloud and Ant Group.

Alibaba Cloud is an on-table business, and Ant Group is an off-table business hidden in Alibaba's equity earnings, with Alibaba holding a 33% stake in Ant Group. Here, let's first talk about the current situation of Ant Group.

1. Ant Group's joys and worries

Before the rectification, Ant Group's core advantages were in payment businesses, creating scenarios and traffic. Financing business (Huabei, Jiebei) is the core of the valuation and cash cow, while wealth management and insurance are the imaginativeness and third-curve business.

The two core drivers of the valuation of Ant Group's financing business: (1) the exclusivity of assets brought by large volume and high-quality risk control, which can attract rich financial institutions and give Ant Group relative bargaining power; (2) Ant Group's asset pricing ability: unique consumer data + high-rate pricing screened by advantages of traffic scenarios and low default rates.

The result of these two factors is that the interest rates of Ant Group's Jiebei and Huabei products are high and the default rate is low. At the same time, the significant volume and strong risk control ability of Ant Group in the market means that for investors, financing from Ant Group for one year is basically without worry, and banks are willing to provide funding at relatively low costs. Correspondingly, Ant Group's financing business possesses the "three highs" characteristics--high certainty, high growth, and high profitability.

Looking back at the five important rectification requirements proposed by the financial regulatory authorities for Ant Group:

1. Correct unfair competition in payment businesses,

2. Conduct personal credit business in accordance with the law,

3. Set up financial holding companies in accordance with the law to ensure sufficient capital,

4. Rectify irregular credit, insurance, wealth management and other businesses, control high leverage and risk contagion.

5. Conduct securities and fund businesses in compliance with laws and regulations, and manage product liquidity risks.

The key issues are the first three items, and the key to the first three items is the direct connection between platforms and financial institutions: traffic belongs to traffic, technology belongs to technology, finance belongs to finance.

The current core solution is to introduce a credit reporting agency (data warehousing and risk assessment) between the platform and financial institutions, which is similar to the inter-bank technical communication system used to handle third-party payments. The possible business relations and charging modes are as follows:

a. Technology Party - Credit Reporting Agency: Based on data obtained from the platform (data warehouse) and using the platform's original risk control model (SaaS), the personal credit reporting agency provides user score, loan pricing and credit line consultation services to banks and other investment parties.

b. Investment Party - Banks and other loan institutions: Based on the evaluation results provided by the technology party, banks provide loans to users, collect interest and control risks themselves.

c. Platform Party - Alibaba, Tencent Jinfu, JD Digits, etc.: Charge investment parties for traffic based on loan amount or other indicators; charge technology parties for cloud services.

In general, this adjustment does achieve the aim of finance being finance, technology being technology, and traffic being traffic. This means that including Ant Financial, Internet finance platforms will most likely rely essentially on core resources such as traffic + data + technology to move from the net interest margin model to the traffic fee + cloud and technology service fee models.

This model also addresses two major issues associated with the rectification:

1. If the platform wants to conduct financial business, it needs to establish an independent entity for regulatory compliance, just like the Ant Consumer Finance Company. The key is to control leverage. Specific rectification measures include:

1.1) Self-operated funds - Ant Consumer Finance Company: In June 2021, Ant established Chongqing Ant Consumer Finance, a licensed consumer finance institution supervised by the China Banking and Insurance Regulatory Commission, to undertake the business of "Huabei" and "Jiebei" behind the scenes of two small loan companies. This part of the business is supervised by the regulatory authority, the China Banking and Insurance Regulatory Commission, rather than by unclear regulatory authorities such as local financial offices for small loan companies.

The most critical issue for this part of the business is the capital increase behind the leverage ratio. Consumer finance companies can use their own funds to lend or obtain external financing, but the financing balance cannot exceed 10 times their net capital (loosely referred to as their own funds).

To support Ant's current loan volume, it can only increase the capital of its consumer finance company. In the latest capital increase approved by the regulatory department at the end of 2022, the China Banking and Insurance Regulatory Commission approved the increase in capital of Chongqing Ant Consumer Finance by 10.5 billion yuan, and the main new shareholder is a company controlled by the Hangzhou government. This will not only help Ant support larger-scale lending business, but also signify that the consumer lending business under Ant has won recognition from the regulatory authorities in terms of its rectification effects.

1.2) External financing - "credit buy, credit loan":

In order to solve the problem of mixed capital sources in Alipay's C-end loans, the portion financed by banks, whether it is an assisted loan or a joint loan, has started to be renamed "credit buy" and "credit loan", and separated from the branding of “Huabei” and “Jiebei” financed by Ant Group.

1.3) After capital increase, what is the upper limit of Ant's loan volume?

In terms of risk control, when small loan/consumer finance companies and banks jointly fund loans, the proportion of investment by small loan/consumer finance companies cannot be lower than 30%.**

After this round of capital increase, the capital of Ant's consumer finance company is 18.5 billion RMB. According to the maximum leverage of ten times, the self-managed loan scale can reach 185 billion RMB. In addition, based on the minimum investment ratio of 30% in a joint loan, Ant's joint loan can lever the maximum loan balance of nearly 620 billion RMB.

Furthermore, based on the approximate proportion relationship between Ant's joint loan (joint loan: all financed by banks, Ant does not invest, only provide traffic) and assisted loan (assisted loan: all financed by Ant, and banks only provide traffic), which is roughly 3:7-4:6 (always stable), the upper limit of the loan balance scale that Ant can lever now can reach around 1.7-1.8 trillion RMB, which is basically similar to the C-end consumer credit balance disclosed by Ant when it went public in 2020, which was around 1.7 trillion RMB at the end of June 2020.

For the subsequent expansion of the loan volume, steady capital increase may be required to increase the scale.

2) Technological Aspect - License and Equity of Credit Reporting Companies

Ant Group and the Zhejiang State-Owned Assets respectively hold 35% of the shares of the Qiantang Credit Reporting Company. The company has submitted an application for a credit reporting license to the central bank, but has not yet received approval from the central bank.

Since some of the equity of this company is held by the company's employees, the share of Ant Group and the holding platform may exceed 50%, which may need attention as a possible adjustment point.

3) The Problem of Financial Control License

After the self-managed financial capital increase problem and credit reporting license issue are resolved, there is still the problem of a financial control license. The central bank requires mixed-ownership operation to have a financial control license. Ant has already been involved in the financial business of payment, financing, and fund sales, thus needing a financial license.

According to expert research, Ant Group has not yet formally submitted an application, and the detailed regulations of the management measures for financial control companies issued by the government in 2020 are not yet complete. Therefore, it may take some time for the financial control license to be implemented, and listing may only be possible with full compliance achieved in business operations. However, with the recent equity changes in Ant Group and Jack Ma giving up actual control of the group, the central government expressed support for the platform economy, and the central bank also stated that the special rectification of financial business by 14 platform enterprises has been basically completed, and a few remaining issues are also being resolved quickly, all of which indicate that Ant Group's rectification is rapidly moving towards implementation.

Although it will take time for actual execution, it can be expected that Ant will rise again, go public successfully, and release the value of nearly one-third of its shares owned by Alibaba Group.

To summarize, Ant Group's business in points 1) to 3) saw significant improvements during the past two years of rectification, and it is now clear that Ant has to go ashore. The downside is that Ant's imagination space has been significantly reduced after this round of rectification. Both loan volume, business model, and actual profitability (interest spread earning ability) have to be recalculated.

However, in the long run, the Dolphin analyst believes that this is a good outcome, as regulatory compliance is the top priority for financial business. After the biggest risk is eliminated, business can at least move at a steady pace.

Regarding valuation issues, based on Alibaba's quarterly financial report that included estimated equity gains from Ant, Alibaba's equity income from Ant in the first three quarters of this year declined by 26% year on year, indicating a significant profit decline at Ant.

The main reason should be the loan balance reduction during the pandemic lockdowns and business compliance process in 2022 (based on research information, the reduction amounted to approximately RMB 500 billion, and the loan volume in 2022 was approximately between RMB 13.4-14 trillion, compared with RMB 17 trillion at the end of the first half of 2020, with the peak around RMB 19 trillion).

Currently, foreign-invested banks invested in Ant have basically reduced the range of the valuation of Ant to between USD 70-150 billion. Previously, when Ant was listed, Dolphin estimated its valuation based on a conservative business model and it was approximately RMB 18 trillion (USD 2.7 trillion).

Here, the Dolphin analyst roughly assumed that the loan volume is suppressed (growth prospects are suppressed), and the loan volume growth rate has changed from being based on the business's own growth potential to following the rate of capital increase. However, the long-term internet credit structure remains unchanged, and after this compliance, Ant remains a leading player, and the industry concentration certainty is still guaranteed.

The core issue is that after this rectification, its revenue and profit prospects will be damaged (assuming interest spread earning capability is reduced from 8% to around 5%). Based on this, the Dolphin analyst roughly discounts its valuation by 60%, corresponding to approximately USD 9.35 million valuation. Based on a 33% equity ratio, Ant contributed approximately USD 30 billion to Alibaba's valuation. 2. What is the future of cloud services for the second curve?

If we say that Alibaba's retail sector suffered its biggest hit since its founding in the second half of 2021, then Alibaba's cloud business has also had a bleak performance. The company's cloud service revenue growth rate was as high as 57% in the natural year 2020, but fell to 30% in 2021, and by the third quarter of 2022, it only had a 4% year-on-year growth, which has clearly failed to play the role of the second growth curve.

Dolphin Analyst believes that in addition to the unfavorable macro environment, the main reason for the slowdown in growth in Alibaba's cloud service customer structure is that internet companies account for the majority of its customer base. Firstly, internet companies have significantly reduced capital investment in 2022 due to regulatory and competitive issues. In addition, internet companies are earlier adopters and more conducive to cloud adoption, so their cloud service penetration rate should be significantly higher than other industries. Accordingly, there will be less room for further increases.

At the same time, during the epidemic, private enterprises generally lacked the desire to expand, and economic growth relied more on government finances and SOE investments. Therefore, Dolphin Analyst believes that whether they can attract To G (government-side) customers is one of the important factors that will affect cloud service companies' performance from 2021 to 2022.

By comparing the cloud service revenue growth rates of internet companies such as Alibaba, Tencent, Baidu, and the three major telecom operators, it can be seen that while the growth rate of internet company cloud services has slowed down, the three major operators have accelerated growth. Furthermore, the overall cloud service growth rate of internet companies and telecom operators is still at around 50-60%, implying that the demand and growth of the domestic cloud service market have not significantly slowed down, and increments have shifted from internet companies to telecom operators.

In addition, is the difference in revenue growth rate mentioned above only due to the lower base of cloud income of the three major telecom operators, and that the majority of the absolute growth still belongs to internet companies? Actually, this is not the case. From the perspective of the year-on-year absolute growth rate of revenue, as early as 2020, the three major telecom operators had already basically divided the same amount as BAT. In the first half of 2022, the three major telecom operators accounted for 90% of the total incremental revenue. Therefore, the trend of operators gradually occupying a share of the cloud service sector's market share and incremental revenue is very clear.

Looking ahead to 2023 and beyond, what will be the growth performance of Alibaba and other internet companies in cloud services? From the current growth rate of the overall number of internet companies and telecom operators, and the forecast for the midterm by iResearch, it can be seen that the future growth rate of China's cloud services will still maintain a relatively high level of 30-40% in terms of their total volume. Meanwhile, with the lifting of epidemic prevention and government support for various private economies such as the internet improving, the investment in private enterprises should be restored in 2023 and beyond, increasing demand for cloud services. Recently, Alibaba communicated that the proportion of revenue from internet companies in Alibaba Cloud's service income has decreased to 48%, and after optimizing the user structure, the burden of a few industries will be alleviated.

Therefore, it can be foreseen that Alibaba's cloud service growth rate will converge with that of the industry from 2023, but the trend favoring telecommunications operators is expected to continue in the coming years.

Based on the above judgments, we expect that Alibaba Cloud's revenue growth rate will significantly rebound to around 19% in the 2024 fiscal year, but still lower than the industry's overall growth rate.

3. Performance and Valuation Estimate

1. How much room for growth does Alibaba's e-commerce sector still have?

Based on our previous calculation of future online retail growth space and judgment on the competitive pattern between Douyin and Alibaba, Dolphin Analyst predicts that Alibaba's domestic e-commerce GMV growth rate will rebound to around 6% in 2023 and the following years.

However, the increment of e-commerce has limitations, and whether the market increment can satisfy the appetite of every player or if Alibaba can realize the expected GMV growth rate requires specific calculations. Therefore, Dolphin Analyst has separately predicted the annual absolute increment of the online retail market under the 11% growth rate threshold and the annual absolute GMV increment of all mainstream e-commerce platforms covered by them. Dolphin Analyst is pleased to find that according to our measurements, the market increment is sufficient to meet the needs of growth for various enterprises, and it is entirely possible for Alibaba to achieve the expected GMV growth rate.

According to our judgment, even after 2024, the pure live e-commerce model of Douyin and Kuaishou will approach the ceiling, and under the premise that it is difficult for them to become shelf-based e-commerce, the increment of the e-commerce market has not been fully consumed. That is, around the final battle of opposing e-commerce between Douyin and Kuaishou, the e-commerce market will usher in a new reshuffle after 2024, and the winner will take the cake that has not been allocated. From the perspective of market share, although we still expect Alibaba to continue losing market share, the downward trend will gradually stabilize by 2025-26. In fact, if Douyin's ambition in e-commerce has not been successful, there is a possibility of Alibaba's market share being restored.

2. Valuation Calculation

Based on our previous predictions and judgments on the three core sectors of retail, cloud business, and financial payment, Dolphin Analyst adopted the method of SOTP sub-valuation this time to predict the reasonable valuation of Alibaba's various sectors and scenarios.

1. First of all, the core of Alibaba's valuation-platform retail (including Tmall, Taobao, and 1688 online wholesale platform). Even if we conservatively expect Alibaba's growth to still be lower than the industry, and due to the loss of growth, it is only given a 10x PE valuation. But based on the expected net profit of $24.3 billion in 2024, the retail on the platform alone can contribute a value of $83 per share. And this is also the safety margin of Alibaba's valuation. When the market sentiment is extremely pessimistic and does not consider any other asset value, it is a good opportunity for value investors when the stock price approaches this boundary.

1. When the market sentiment is neutral, we take the core platform retail + the second growth curve cloud business + the most valuable Ant Group in the clan assets + the company's net cash as the company and valuation anchor. For the cloud business, it is calculated at $19 per share based on the revenue in 2024 and 4x PS (equivalent to a net profit margin of 20% under steady-state and a PE valuation of 20x). According to the previous calculation, the total valuation of Ant Group is $93.5 billion, multiplied by Alibaba's 1/3 equity ownership and the group's depreciation, which is equivalent to a valuation of $9 per share for Alibaba. Plus $17 per share of net present value, the reasonable value of Alibaba under neutral expectations is $128 per share.

2. If the market sentiment enters the optimistic range, in addition to the above core assets, when the market also starts to give valuations to edge businesses such as Cainiao, local life, and new retail, Dolphin Analyst calculates that Alibaba's optimistic valuation per share is $153. However, Dolphin Analyst also needs to remind investors that this situation generally only occurs when market liquidity is extremely abundant or when Alibaba begins to prepare for the listing of the above assets to release value.

In addition, Dolphin Analyst also conducted a cross-valuation calculation through the DCF model. Assuming a WACC of 11% and a perpetual growth rate of 3%, the reasonable valuation of Alibaba per share is $136.6, which is in the middle area of Dolphin’s SOTP valuation.

Dolphin Investment Research on Relevant Studies in the Past:

【Industry】

January 5th, 2023 "The Situation Reverses: 'Alibaba, Ctrip, Didi' Launch Counterattacks"

September 30th, 2022 "Pinduoduo vs. Vipshop: Is Your 'Poor Day' Their 'Good Day'?"

September 22nd, 2022 "[Alibaba, Meituan, JD.com, and Pinduoduo: Have They All Resigned to Their Fate? They Still Have to Strive for the 'Great Fortune'] (https://longbridgeapp.com/topics/3457950)"

April 27th, 2022 "Alibaba vs. Pinduoduo: After the Bloody Battle, Only Coexistence Remains?"

April 22nd, 2022 "Why are Meituan and JD.com Doing So Well in the Stock-based Grind?"

April 13th, 2022 "As the Cycle 'Decays,' How Much Value do Alibaba and Tencent Still Have?"

【Company】

January 18th, 2023 "The Ultimate Battle: Can Taobao Compete with Douyin?"

November 18th, 2022 Telephone Meeting "Alibaba: 'Actively Preparing for a Post-Epidemic World'"

November 18th, 2022 Financial Report Review "Alibaba: The Loss Explosion is Only a Paper Tiger; the 'Competition Deadlock' is the Fatal Blow"

August 4th, 2022 Telephone Meeting "Without User Growth, Alibaba Focuses on Wallet Share, Seeking Quality and Efficiency (Telephone Meeting Minutes)"

August 4th, 2022 Financial Report Review "[The Frugal Alibaba: 'Risking Life and Limb for Money'] (https://longbridgeapp.com/topics/3251434)" On May 26, 2022, the telephone conference call on "Sustainable Management and User Expectations for Recovery (Alibaba Telephone Conference Summary)" was held.

On May 26, 2022, the financial report review on "After a 70% Plunge, Alibaba Finally Sees the Dawn of a Turning Point?" was conducted.

Risk disclosure and statement: Dolphin Research Institute Disclaimer and General Disclosure.