Comments on Alibaba’s Second Quarter Earnings.

How New Management is Steering Alibaba Toward Recovery

I’ve been very critical about Alibaba BABA 0.00%↑ in the past, as you can see in my previous articles here and here. However, despite the somewhat disappointing numbers this quarter, I believe things are gradually improving at Alibaba. The key reason for this shift is that the new management seems to have finally overcome the leadership mistakes made under former CEO Daniel Zhang.

Under Zhang’s leadership, Lazada lost to Sea, Ele.me lost to Meituan, AliExpress to Temu/Shein, Taobao/Tmall to PDD, and the cloud business didn’t perform well either. All were losing market share or their dominant positions while incurring huge losses, except of Chinese e-commerce. Or worst of all, his new retail idea with Sun Art, Freshsippo, and Intime, which the current management absolutely despises. This is from their first-quarter call, where they blame weak performance on those exact acquisitions.

Excluding Sun Art, Freshippo and Intime businesses that have physical retail operations, group revenue would have grown at approximately 11%, and our group consolidated adjusted EBITA margin would have been approximately 3.6 percentage points higher at approximately 21%.

New management has now established a clear path forward and are executing their strategy with purpose. (Here Joe Tsai talks about that.) In previous earnings calls, there was a lot of focus on past mistakes and a sense of frustration, but now the tone is more forward-looking and optimistic.

But of course, they can’t resist mocking Daniel Zhang, at least a bit.

In the past, Alibaba Express was perhaps a low-efficiency kind of platform that too often offered consumers a relatively poor user experience, but we’ve been working very hard on improving that.

A clear strategy emerges

The strategy Alibaba is now pursuing is straightforward: a strong focus on e-commerce, both domestically and internationally, supported by their logistics businesses, Cainiao and Ele.me, for fast delivery in China, along with cloud computing. The rest of their operations are considered non-core and may be divested if a reasonable valuation can be achieved. Until that point, management expects all of these units to become profitable within the next one to two years.

This wasn’t always the case, as you might recall when there was talk of spinning off the cloud business or Cainiao. Back then, Alibaba seemed to be struggling with direction and cohesion. Now, however, it appears that they’ve found their rhythm. The current strategy reflects a more focused and confident approach, with management clearly committed to executing their plan without the uncertainty that previously plagued the company.

While all of this sounds promising, it will take time. Even if they are now making the right decisions, it will take several quarters before these changes are visible on the balance sheet - see some of their comments below.

If we have a good quarter, it’s because of the work we did three, four, five years ago. It’s not because we did a good job this quarter.

— Jeff Bezos—

Challenges and Opportunities: Alibaba’s Share Repurchase Strategy and the Road to Growth

Meanwhile, Alibaba repurchased $5.8 billion worth of shares, resulting in a net reduction of 2.3% in shares outstanding after accounting for share-based compensation. During the earnings call, Alibaba emphasized a shift away from share-based compensation toward long-term monetary benefits. This strategy helps avoid share dilution, which is particularly important given the current undervaluation of the shares, and allows the company to compensate staff in China with RMB, reducing usage of US dollars. Alibaba maintains a strong financial position with a net cash balance of $55.8 billion. Additionally, Alibaba expects to complete its primary listing in Hong Kong by the end of August.

However, share repurchases and bringing non-core business units to break even are not enough to drive the shares to higher multiples. For that, it is absolutely crucial that the Chinese e-commerce and cloud businesses return to double-digit growth. While the cloud business appears to be on track to achieve this, the Chinese consumer e-commerce segment faces tougher challenges. Fierce competition with Pinduoduo PDD 0.00%↑ , Douyin, and Kuaishou, combined with weak consumer spending in China, means that this recovery might take more time.

This is from the last Tencent call:

FinTech Services revenue growth decelerated to a low single-digit percentage rate, impacted by further moderation in commercial payment revenue growth that reflected slow consumption spending.

Summary:

I believe things are moving in the right direction for Alibaba. Management changes are beginning to pay off, and a clear strategy is now in place. The key now is execution, and early signs of better execution are evident. However, it will still take time to fully turn things around, particularly in the Chinese e-commerce sector, which faces the fiercest competition and remains the most crucial element in Alibaba’s overall success.

If you’re interested, below are more detailed notes on the different business units from my personal investment journal.

Chinese E-commerce (Tmall and Taobao Group):

In Alibaba’s Chinese e-commerce segment, which includes Tmall and Taobao, the company is facing challenges, with revenue and adjusted EBITDA both declining by 1%. However, there are signs of recovery, as they have achieved high single-digit GMV growth and double-digit order growth year-over-year. Management expects the gap between GMV and CMR growth to close as monetization efforts increase. Initiatives like the Quanzhen Tui marketing tool are being introduced to help align revenue with GMV growth. Alibaba plans to implement a 0.6% technology service charge starting in September to further enhance monetization. Additionally, they are scaling down direct sales in consumer electronics and appliances, viewing these asset-heavy business models as subpar. Management has repeatedly stated that market share is slowly stabilizing, a point they had previously avoided addressing in earlier calls.

Cloud Business:

Alibaba’s cloud business grew by 6% this quarter, with adjusted EBITDA also increasing. Notably, the cloud business generated RMB 1.5 billion in new revenue this quarter, which led to an equal RMB 1.5 billion increase in EBITDA—demonstrating that cash flows are directly contributing to the bottom line. The company anticipates double-digit growth in H2 2024, driven by a shift from traditional CPU-based cloud services to AI-related offerings, which are experiencing triple-digit growth while phasing out low-margin projects. For Tencent, the same playbook worked well, and they are already back on the growth track.

Similar to major U.S. tech companies and Tencent, Alibaba is heavily investing in CapEx and AI capabilities, which is impacting free cash flow. However, the new compute power is expected to be fully utilized from day one, ensuring that these investments translate into immediate revenue, with a very high ROI anticipated. They also noted that demand for AI-related services is far from being fully satisfied.

Alibaba’s cloud strategy focuses on two key areas: helping existing customers implement AI capabilities and attracting AI-native enterprises by offering computing power in exchange for equity stakes. I wrote more about this exchange for equity here.

International E-commerce:

Despite incurring significant losses, this segment is growing at 32%, driven by Alibaba Choice and Trendyol in Turkey. Alibaba Choice is not only experiencing rapid growth but also improving its unit economics by 20% quarter-over-quarter. A significant positive development is Lazada, which became EBITDA positive for the first time in July. The strategy is: focus on profitability, consolidate market share, and eventually contribute significantly to Alibaba Group’s earnings at scale.

Local Service Group (Ele.me and AMAP):

Losses reduced by 81%, indicating a successful shift towards monetization.

All other business:

This segment has returned to growth, with a 3% increase in revenue and a 25% reduction in losses. The positive results are driven by improved operations in SunArt, Fresh Shippo, Alibaba Health, and Lingxi Games. However, revenue is being negatively impacted by the winding down of SunArt, and profitability improvements are partially offset by increased investments in the technology business, particularly in DingTalk and Quark. These are promising results, and once these units are polished, they might be divested if valuations are favorable. I wrote about the positive developments in Fresh Shippo (HEMA) here.