Alibaba Group Holding Ltd (BABA) is not only the world’s largest retailer by merchandise volume, but it is also showing no signs of slowing down with double-digit growth in this area.
This, along with an investment portfolio that’s worth billions of dollars, and includes Ant Financial, would make you think that BABA would be one of the most valuable companies in the world, if not the most valuable.
Instead, it is valued right around $200 billion, which isn’t cheap, but does leave many companies like Amazon.com, Inc. (AMZN) and Facebook Inc (FB), which also operate through the web and have far less free cash flow, with much more value.
While much of Alibaba’s outlook has been tied to GMV growth to this point, all of that is changing, and one of the two big catalysts that surround BABA stock is now playing out.
The Big Catalyst(s) for BABA
The first catalyst that could push Alibaba stock significantly higher is a share repurchase program worth upwards of $25 billion. Alibaba has a very profitable business, where it essentially collects advertising and marketing revenue, and does not actually rely on products sold to create revenue or profits.
That means it has high margins, which has allowed BABA to produce nearly $6 billion in free cash flow last year, in addition to its $17 billion cash pile. As explained in an article late last year, Alibaba’s profit, cash and strategy to invest in value all make a massive share repurchase plan very likely in the foreseeable future.
With that said, the likelihood of this catalyst becoming a reality increased substantially after Alibaba’s fiscal fourth-quarter earnings, where the second catalyst is playing out to perfection.
That catalyst is a rising take rate, where BABA stock and revenue creation is no longer tied exclusively to GMV growth, but rather its effectiveness to monetize merchandise volume and drive revenue growth that significantly outperforms GMV growth.
Good News for BABA stock
During Alibaba’s last quarter, its marketplace GMV grew just 24% to $115 billion. Yet, Alibaba’s revenue rose 39%, with revenue from its Chinese retail marketplace increasing 41%. Both showed an acceleration of growth from the previous quarter’s 32% growth.
The reason is that Alibaba’s monetization rate, or take rate, rose from 2.17% last year to 2.47%. And while spending remains aggressive, BABA still managed to nearly double income from operations despite such a big increase in its take rate.
This suggests that the companies who are advertising or marketing their products on Alibaba’s platforms are seeing increased value for doing so. In retrospect, BABA is much like Facebook, as both rely on the willingness of advertisers and marketers to pay more for ad products to drive revenue growth. The difference is that BABA still has a tremendous amount of GMV growth.
With 1.65 billion monthly active users, it is unrealistic to think that Facebook can double its users, which means ad pricing and the ability to create successful products is what drive top-line performance.
Meanwhile, Alibaba’s GMV is growing 20%-plus, and the majority of its merchandise volume comes from China.
The good news is that BABA has built infrastructure and is rolling out platforms to create GMV growth all throughout Asia and in new markets like India, North America and even Europe. Thus, BABA could double its sales and profits on GMV alone, without its take rate increasing at all.
However, Alibaba’s take rate is rising, and rising quickly. As it becomes more of a global e-commerce juggernaut, advertisers and marketers will be willing to pay more in exchange for reaching a larger audience and/or selling their goods throughout the world.
In looking at BABA stock, Alibaba’s ability to drive its take rate higher is the single greatest catalyst for long-term appreciation, and with the stock trading at such an attractive multiple to free cash flow, investors can conclude that there is tremendous upside from this point forward.
As of this writing, Brian Nichols was long Alibaba.
