Alibaba Stock: firing on all cylinders (NYSE: BABA)

After facing huge regulatory headwinds in China, Alibaba (NYSE: BABA) management wants to focus on international operations to diversify the revenue base and enter new growth markets. One of the most lucrative marketplaces for Alibaba is Europe where business expansion is going full steam ahead in important services. Different regions in Europe have their own regulatory environment, which also allows Alibaba to focus on key regions.

A good example is Trendyol in which Alibaba owns more than 85% of the capital. Trendyol is one of Turkey’s leading e-commerce players with a valuation of $16.5 billion or 5% of Alibaba’s current market cap. Alibaba has a major advantage over local players because it can absorb losses longer than smaller players.

Alibaba also offers a host of services such as payments, cloud, delivery and others through which it can monetize its international customer base. Alibaba will also have an advantage over Amazon (AMZN) in Europe as it can source directly from Chinese manufacturing facilities through its local supply chain. If Alibaba continues to show strong progress in Europe, this region will be a key driver of stock growth in the coming quarters.

Focus on Europe

Europe has key factors working in favor of Alibaba. Alibaba was unable to expand in the United States due to regulatory and political restrictions. Alibaba also withdrew most of its investments from India after border tensions between India and China. However, European regions are more conducive to Alibaba’s investment. It is possible that Alibaba can see a positive regulatory environment in Europe as long as it convinces them of good privacy and data security measures.

Figure 1: Market share of the main e-commerce players in Eastern Europe. Source: Bloomberg

The European market is also one of the largest in the world with a nominal GDP of over 23 trillion dollars, or 30% of global GDP. The e-commerce market is still in its infancy in this region compared to the mature phase seen in China and the United States. Another key factor in Europe is that there are different regulatory practices in different regions. Therefore, UK regulations would be different from Poland, which would be different from Turkey. Alibaba can focus its investments where the regulations are more attractive to establish a foothold and build its logistics.

We have already seen this with its massive stake in Trendyol which is the second largest e-commerce player in Turkey. Alibaba owns more than 85% of this company and has a valuation of $16.5 billion according to the latest funding round. Alibaba is among the top three e-commerce players in Poland, Croatia and many other Eastern European countries.

Opportunity for Alibaba Cloud

While e-commerce remains the most visible part of Alibaba’s operations, real profits and margins going forward will come through its cloud operations. Europe is a very important market for Alibaba Cloud. Currently, Alibaba Cloud’s EBITA margin is 1% while Amazon’s AWS has reported a margin of nearly 30% in recent years. Therefore, there is a huge gap in the margins of these two cloud giants.

The main reason for Alibaba’s low margins is that most of its revenue comes from China, which remains a more value-driven market. If Alibaba competes directly with Amazon, Microsoft (MSFT), Google (GOOG) and other cloud players in Europe, we should see rapid improvement in margins as Alibaba’s cloud margins approach those other cloud companies.

Figure 2: Alibaba’s cloud business revenue and margins. Source: Company Filings

Alibaba Cloud has an annualized revenue base of over $12 billion, which represents 9% of the company’s total revenue base. The growth rate in this segment is also higher than in the core trade segment. Alibaba Cloud’s strong growth in Europe will improve future growth track and improve bullish sentiment towards the stock.

The European market is very diverse where different countries have their own approach towards foreign technology companies. Many countries prefer a mix of different companies instead of relying solely on US tech companies. This should help Alibaba gain market share as long as it can ensure data security and privacy for regulators in this region.

Underestimating growth opportunities

Alibaba’s opportunity in Europe is massively underestimated. The company has built a strong ecosystem in China and now needs to replicate it in Europe across different regions. Margins in various business segments such as cloud, subscription and advertising could also be higher in Europe than in China.

Alibaba has a strong supply chain in China where it picks up manufactured goods from factories and delivers them directly to customers. The company can take advantage of this business model by extending its supply chain to Europe. It would be very difficult for Amazon to replicate this supply chain with similar margins as it does not have a large presence in China. Small local e-commerce players in Europe will also not be able to compete with Alibaba in terms of logistics.

Amazon still holds a leading position in Western European countries like France, Spain, UK and others. However, Alibaba is showing stronger growth as it expands its logistics operations. While evaluating these operations, we should consider a multi-year growth trajectory, as it takes a long time to build the required warehousing, logistics and delivery network. Alibaba is on the right track in its European operations, which should see the company gain considerable market share in the coming years.

Impact on Alibaba shares

Alibaba faces huge regulatory hurdles in China and therefore needs to diversify the revenue base outside of China. Rapid growth in Europe would give Wall Street confidence in the company’s direction and business model. Alibaba is already a big player in many parts of Europe. Alibaba-owned Trendyol is the leading player in Turkey. In recent months, Trendyol was valued at $16.5 billion, or 5% of Alibaba’s total market cap. Alibaba has a strong presence in many other European countries and standalone valuation in these regions would increase as Alibaba improves its operations.

Figure 3: Trendyol shows near triple-digit annual growth in Turkey. Source: Alibaba Repositories

Figure 4: Customer management activity within Core Commerce was down 1% year-on-year. Source: Alibaba Repositories

Alibaba’s local business in China is reaching saturation as the company has reached the entire addressable market. On the other hand, the growth avenue in international markets like Europe is much larger. It is likely that much of the future appreciation of Alibaba shares will be based on the company’s performance in these international regions.

Alibaba can expand into e-commerce, cloud, payments, delivery, subscription, advertising and other segments in international markets. After the initial phase of heavy investments in logistics, we should see better margins from its European operations.

We can also look at market share metrics from Alibaba and Allegro, which is the leading e-commerce company in Poland. Allegro has a 36% e-commerce market share in Poland, while Alibaba has nearly 3% in this region. Alibaba is expanding its logistics capacity to improve customer retention in this region. Allegro’s PS ratio is significantly higher than Alibaba. The main reason is that Eastern Europe is still considered a growing e-commerce market, while China’s e-commerce operations are in a mature stage.

Alibaba’s ecosystem of services is also much more developed than smaller local players. It is also possible for Alibaba to absorb losses in these markets longer in order to gain market share.

We should see good progress from Alibaba in Turkey, Poland, Spain and other European markets in the short to medium term. This will help diversify Alibaba’s revenue base and provide a better avenue for growth for the company. The impact on Alibaba’s valuation is expected to be massive as the company reports a higher share of revenue from these international operations compared to its home-based business in China.

Key takeaway for investors

Alibaba’s European business is running at full speed. The company is looking to expand into different regions with a host of services including e-commerce, payments, cloud, delivery and others. It is likely that Alibaba will earn better margins in Europe as this market has not reached a saturation point similar to China. A big growth opportunity for Alibaba will be in the cloud sector where it will directly compete with US tech majors for market share. This should reduce the margin gap that the company has compared to other cloud players in the United States.

The rapid expansion in Europe will reduce the regulatory worries the company faces in China. Alibaba already has an advantage over Amazon in this region thanks to a strong connected supply chain in China. We should see an increase in Alibaba’s market share in e-commerce and other services in Europe over the coming quarters, which will become one of the key growth drivers for the stock.