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Making Sense of Alibaba's September Q21 Earnings Call (Nov. '21)

Making Sense of Alibaba's September Q21 Earnings Call (Nov. '21)
By Dudley Glen • Issue #5 • View online
After the latest earnings release on November 18, 2021, Alibaba stock sold off and finished the day -11.13% and stock performance ended the day at -38.3% YTD.
This article will discuss whether or not this drop was justified and put the earnings call into greater context.

  1. How The Core Business Works
  2. September Quarter Performance
  3. Conclusions
How The Core Business Works
Core Commerce>
Alibaba is a complex organization with multiple layers of businesses, so it’s important to understand at least how the core business works and what the drivers of success are.
Alibaba’s core eCommerce business primarily monetizes through advertisements and other technology services that are used while connected to their platform. This makes Alibaba’s business distinct from many of its competitors that often come to mind when you think of eCommerce, like Amazon or JD.com who own their own logistics. If you are a business and you want to sell online, Alibaba has all of the tools you need to get started quickly and effectively.
What drives Alibaba’s Core Commerce revenue?
  1. How many users are on the platform: Annual Active Consumers (AAC). If you were thinking of this in terms of fishing, you could equate this to how big your net is when you throw it into a river full of fish.
  2. How much revenue is transacted on the platform: Gross Monthly Volume (GMV). If you were to equate this to fishing, you could think of this as how many fish you actually catch.
  3. What percentage of this revenue goes to Alibaba: Customer Management Revenue (CMR). Again, for our fishing analogy, this is what percentage of the fish you caught that you get to keep for yourself and your family.
Cloud>
Once you get the Core Commerce picture, it’s really easy to see how it would be natural for Alibaba to also have a sticky and successful cloud offering.
If a business already has Alibaba running its eCommerce operation, it would be just a matter of up-selling to get them to store all of their other data on Alibaba’s servers and then digitize their entire organization using the tools on Alibaba’s Cloud. This move for Alibaba is now only in the early stages and Cloud currently accounts for just less than 10% of their overall revenue.
September 2021 Quarter Performance
Let’s start with revenue first so you can get an overall picture and then can discuss the other pieces.
REVENUE>
Total Revenue +29% YoY
China Commerce +30% YoY
International Commerce +34% YoY
Cloud Computing +33% YoY
As you can see, growth across these segments is actually quite good. However, there are two major concerns analysts had with this revenue number after the earnings call.
First, Wall Street was expecting revenue of $32.08 billion and actual revenue was $31.4 billion. With $680 million (≈2%) less in revenue than expected, this counted as a “revenue miss” and gives the street one strike against Alibaba for this quarter’s earnings, even though their performance represented strong 29% year over year growth.
Second, on the earnings call, Daniel Zhang lowered his revenue guidance, or how much is expected, for 2022 revenue growth.
Given a slower-than-expected domestic consumption growth, since we provided our revenue guidance in May, we now expect our fiscal ‘22 revenue growth to be 20% to 23% year over year.
So, we have to ask ourselves, why was revenue less than was expected and why are revenue forecasts being lowered for next year?
The first thing to think about is>
  1. Where do these expectations come from?
  2. Why are these expectations so important?
We can save that discussion for another day.
Anyway, if we want to investigate the revenue miss and lower forecast, we should start looking at the drivers of revenue mentioned above.
How did those drivers hold up?
ANNUAL ACTIVE CONSUMERS (AAC)>
Total 1.2 billion (+62 million/+5% vs. last quarter)
China 953 million* (+41 million/+4% vs. last quarter)
International 285 million (+20 million/+8% vs. last quarter)
*Analysts projected 846.6 million
So, you can see that Annual Active Consumers is growing rather quickly. On the earnings call, Daniel Zhang, Alibaba’s Chairman and CEO mentions the pace of growth and the growth for the future:
Our global annual active consumers reached approximately 1.24 billion, which is a net increase of 62 million quarter over quarter, and 20% growth year over year this past quarter. Our AAC grow to 953 million in China and 285 million overseas. We are on track to deliver the 1 billion China AAC target by the end of this fiscal year and remain firmly committed to achieving our long-term target to serve 2 billion consumers globally.
To put that in perspective, Alibaba added a number that equates to nearly 20% of the US population in just the September quarter alone.
You should also notice that China’s AAC is growing more slowly than international commerce. That’s because there are 1.4 billion people in China and Alibaba is starting to hit a ceiling. It’s not certain what the final number could be or when exactly it will stop, but it will, because….math.
It doesn’t appear that the reason we are seeing lower revenue now and in the 2022 forecast is because we are aren’t adding customers fast enough.
However, it could be that Alibaba is adding most of their new consumers in parts of the world where the Alibaba brand isn’t as strong or there are other obstacles to growing in the same way that they did in China (like logistics for example). That would lead to a lower GMV in those areas.
GROSS MONTHLY VOLUME (GMV)>
Our next step takes us to investigate the monthly volume that is transacted on the platform. Again, this is revenue that happens on the platform, but that revenue does not belong to Alibaba, it’s just a net full of fish that Alibaba can take a small slice from.
Zhang spends time on the call reassuring investors that China’s macro consumption is strong:
Looking forward, we remain confident in development of China consumption. Today, we already have the largest and the most valuable consumer base in China with 953 million AACs, which are still growing. At the same time, we will serve our large and diverse consumer population through user segmentation, addressing different needs and use cases through an assortment of apps with differentiated value propositions. Further through cross-selling of products and services, we will increase our user stickiness, wallet share and overall retail penetration.
So, if China’s consumption is strong, why is revenue lower?
The earnings call gives us two possible explanations:
First, China’s consumption overall is down, and China’s projections for consumption next year are also down.
CFO Maggie Wu explains that Alibaba’s performance is so large now that it is inextricably tied to China’s overall consumption:
China’s NBS [National Bureau of Statistics] statistics have shown a slowdown of overall consumption. We experienced a larger impact given our position as the largest e-commerce player in China.
Wu later elaborates:
And we, as the, in size, the biggest player right now comes for – we have approximately 8 trillion GMV versus 44, 45 of the total national GMV. So the impact will be largely on us.
You’ve got that right. Something like 20% of China’s national GMV happens on Alibaba’s properties. Astounding.
Second, there has been fierce competition in China’s eCommerce market from competitors like Pinduoduo, JD, and others.
Notice that while Zhang is defending China consumption above, he’s also talking about strategy. Alibaba is no longer the only big eCommerce player in China, so they have to be more strategic about their product offering now that they have the largest platform.
You can think of this the way Facebook added tons of users for free and then built an ad revenue model on top of it. The users came first. Alibaba is doing the same thing.
Wu details the new competitive landscape here:
So firstly, in China, we’re seeing more players enter into the e-commerce industry. Our peers are increasing investments to acquire users and most of them continue to show level of – high level of spending. We will continue to invest in our e-commerce business that create value for consumers and merchants and keep our market leadership position and then for the competitive strength in longer term. Secondly, we believe our local service business still have ample long-term potential. These businesses have generated strong transaction growth and high user retention rate, setting a strong foundation to compete for the long term.
Wu assures us that Alibaba’s core commerce will still do well in the future, but the game has changed. Competitors need to add consumers and merchants in China the same way Alibaba had to, so they will do absolutely anything to add them, including incur losses in the short-term. Otherwise, they will soon disappear.
Given the two factors above, it’s very difficult for us to peel apart whether Alibaba’s lower revenue resulted from a less conducive macro environment, or if it was because their competitors are eating their lunch. It’s probably a little bit of both.
Keep in mind that while all of this is going on, we’ve also had global supply issues, Covid lockdowns, and lots of new regulations, all which might be disrupting normal commerce in ways we can only speculate.
There’s probably more we can glean from getting data and information from the earnings calls of Alibaba’s competitors. If it isn’t competition that’s bringing Alibaba’s revenue down, you’d expect results from Pinduoduo, JD, and others to also reflect a decline because of a decline in Chinese consumption generally. If competitors were not being affected by a slowdown in consumption, it could mean that they are stealing market share from Alibaba.
Another key thing to look at is retention on the platform. It costs much more to acquire new customers, so looking at churn is really helpful. On the earnings call, Maggie Wu assures investors that retention is strong and more information on how they measure that will be provided on the investor day in December.
A few points to make about losing market share>
First, losing market share doesn’t by itself make a company or shareholders worse off. For example, a company like Alibaba with 80% market share years ago might actually be more efficient and profitable if they focused more heavily on high-margin segments like luxury retail, etc. and built the business on lifetime value rather than short term earnings. Since eCommerce is a growing pie, growth by several companies is not a zero sum game. If Alibaba can capture high-margin revenue, loss of market share might ultimately mean more free cash flow and therefore more shareholder value in the long run. We believe that that is Alibaba’s strategy.
Second, Alibaba has around a billion users in the Chinese market alone. Since their platform is asset light, it’s possible for them to simply rewrite computer code to adjust their product/market fit to and then be able to beat back competition in short order. They can react much faster than other companies can. This is an advantage that not many companies in the world have.
To get a clearer picture, imagine you have 1,000 physical stores and you want to change the way they all feel to consumers. That would be much more difficult than writing computer code and pushing out an update.
Finally, China recently passed regulation forcing Tencent to open up WeChat to Alibaba’s properties (Alibaba had to do the same). It’s likely they have been slow to make that change, which means Tencent could still be using its’ “walled gardens” to protect JD and PDD (which they have significant investments in). WeChat is THE platform in China, one that nearly everyone uses. In the past, Tencent blocked Alibaba’s links from working across their platforms. Once the walled gardens come down, it’s possible it could boost Alibaba’s business. In the most extreme scenario, it could be that this quarter’s earnings miss were greatly impacted by Alibaba’s walls coming down before Tencent’s.
CUSTOMER MANAGEMENT REVENUE (CMR)
On the earnings call, Daniel Zhang spent a little time discussing CMR and then it came up again later in the Q&A.
Zhang says:
And CMR is growing 3%. There are two key reasons for the slower growth of CMR. First, our CMR growth were primarily tied to single-digit, physical, good GMV growth that resulted from slowing market conditions and more players enter into this sector of the China e-commerce market. China’s NBS statistics have shown a slowdown of overall consumption. We experienced a larger impact given our position as the largest e-commerce player in China. Secondly, CMR growth was lower than physical goods GMV growth, primarily due to the incremental year-on-year increase in merchant support and subsidies.
Since CMR is basically Alibaba’s take home money from eCommerce, it’s really important that this number continues to grow. As discussed earlier, GMV took a hit from increased competition and Chinese macro factors, so it makes sense that CMR would as well.
The 3% YoY growth figure that Zhang mentions above can be contrasted with the 14% YoY number reported in Alibaba’s previous earnings call. The numbers this quarter showed that it did not grow as fast as expected.
An analyst from Goldman Sachs asked about this in the Q&A and Maggie Wu makes a few important points:
  1. CMR is becoming a smaller and smaller portion of Alibaba’s revenue as other growth engines are ramping up (like cloud and the international business)
  2. Ad revenue in CMR will be only one of many ways to monetize the core commerce part of their business in the future.
  3. If Alibaba removed their merchant support programs, CMR would be roughly in line with growth in GMV.
This seems to be the long-term strategy behind the “merchant support and subsidies.” Alibaba’s goal is to build the largest platform possible, so they need to add to both sides of that platform. They need to add merchants as much as they need to add consumers. Now, imagine you are a sneaker company and you want to sell on Alibaba, but you have a very promising, but struggling business. Now, next imagine that Alibaba comes to you and says they will financially support you a bit while you get up and running. THAT is a huge value proposition and is likely to create life-long relationships. These merchants will be become the most faithful on the Alibaba platform because they will credit Alibaba for getting them started or solving a major problem early on. However, for Alibaba, this comes at a short-term cost. This is exactly what you want to see as a long-term investor.
Analysts worry that Alibaba is paying merchants to stay on their platform and that if the subsidies were to go away, merchants would leave for competitors. Special attention must be paid to this because, previously, there was a “picking one from two” practice where platforms like Alibaba would force merchants into distribution exclusivity where they would punish merchants if they used multiple platforms (like using both Alibaba and Pinduoduo to sell). This practice of exclusivity has since been disallowed by the Chinese government and it’s possible for merchants to distribute on multiple platforms. This means, the platform with the highest value to each merchant will win out and it’s even possible that several different platforms will be used for different niche products by the same merchant (which is the norm in other countries).
We believe that Alibaba has a strong enough offering to maintain their merchant base despite competition. Even if you ignore the relationship and goodwill generated by these subsidies, once a merchant is hooked into the Alibaba ecosystem, especially if they use their cloud infrastructure, switching would be highly unlikely. Again, to make it clear, imagine you get on this platform that allows you to quickly and effortlessly sell your product to almost every country in the world. You get education and practice with the platform and sales are improving every quarter. After a while, you realize you don’t need as many staff or as much infrastructure, so you eventually become extremely profitable. How likely are you to switch off of this? Alibaba’s platform is incredibly sticky for merchants and it’s even more sticky if they start digitizing with Alibaba’s cloud offering.
What’s also interesting is this phenomena is almost exactly the same story we heard a few years ago when Alibaba crashed on September quarter earnings. Reading this article in Forbes from November 2018 is like deja vu with talk about regulations and all. After that crash to $132 in 2018, the share price went fluctuating up and down until it reached a high of $310 in October 2020, almost exactly two years later.
It seems quite normal that a slowdown in China’s economy means a slowdown in GMV means a slowdown in CMR.
EARNINGS>
This quarterly Alibaba’s earnings were 11.20 vs 12.11 expected (-37.7% YoY).
What’s immediately interesting is that during Alibaba’s August earnings call, Daniel Zhang reiterated that at the beginning of the fiscal year Alibaba was going spend more capital and change their strategy, which was likely to impact earnings. This guidance actually caused a sell-off of the stock price after the August earnings call. After the November earnings call, the financial results of this seemed to surprise analysts a second time, which is puzzling.
Here is what Daniel Zhang said on the August earnings call (link to the full transcript below):
Over the past 22 years, Alibaba has grown into a company encompassing consumer Internet and industrial Internet with multiple engines driving our long-term growth. In consumer business, we operated the largest consumer marketplace globally with 1.18 billion annual active consumers as of June 30, 2021. During the first fiscal quarter, our annual active consumers grew from 890 million to 912 million in China and from 240 million to 265 million outside of China, representing quarterly net adds of 45 million in total.
At the beginning of this fiscal year, we announced a plan to invest all of our incremental profit this year into core strategic areas such as technology innovation, support programs for merchants to lower their operating cost, user acquisition and experience enhancement, merchandising and supply chain capabilities, infrastructure development and new business initiatives.
They were designed to enlarge our total addressable market, differentiate consumer and merchant value propositions from our competitors and generate greater consumer engagement and purchase frequency.
Given that Zhang said he would “invest all incremental profit,” it should be clear that Alibaba is shifting more toward the Amazon “we’ll make money later” model. Investors reacted negatively to this after both earnings calls.
Getting back to Alibaba’s merchant subsidies, Zhang speaks about how this impacted earnings:
Commerce adjusted EBITA decreased by 12.7%. The decrease reflects – 12.7 billion. The decrease reflected increased investment in those strategic initiatives. Now, these initiatives we invested within commerce, as noted, we’re investing in growth business that strengthen consumer experience, enhance loyalty, penetrate into less developed area in China and further expand our presence internationally.
The best way to think of these subsidies then is to think of the strategy Amazon used when they were growing early on–they basically showed no short-term profit because they were entirely focused on building long-term value. This meant that a lot of investors simply gave up on them and there was a lot of writing in the press about how they were a charitable organization. Now we can see how wrong they were and how right this strategy is.
Another part of Alibaba’s business that we haven’t discussed much here is their portfolio of equity investments. When Alibaba has spare cash, they tend to invest it much like a venture capital firm in addition to their investments in publicly held companies. Much of the time, the investments are soft-power investments where they can solidify relationships through capital so they can build long-term mutually beneficial partnerships which advantages Alibaba over competitors. This is how they tend to operate their logistics (see Best, Inc.) They also have investments in organizations such as Indian firm Paytm, EV company Xpeng, and many many others.
The reason to bring this up is that one reason why earnings took at a hit is because these equity investments didn’t perform well over the last quarter, which negatively affected earnings. China’s Hang Seng Index has been in a bear market since February 2021 and seems like it may turn around soon. This has impacted many of Alibaba’s domestic investments including Xpeng.
Finally, when you look at YoY earnings, taxes also play a role. Alibaba received a tax credit in 2020 which reduced the amount they need to pay in taxes, which meant more earnings for that year. When you compare that to this year, it isn’t a fair comparison.
So, our reduced earnings can possibly be boiled down to a combination of the following:
  1. Decrease in market prices of equity investments
  2. Increase in taxes
  3. Increased competition
  4. Reduced China consumption and/or macro factors like Covid and supply chain issues
  5. Investments in platform growth and other projects
Conclusions
Though there was a large sell-off and the media surrounding the earnings call was negative, the quarterly results are much less concerning and we believe this is a buy-the-dip opportunity for the long-term investor.
Alibaba is prioritizing platform growth, both on the merchant and consumer side, over short-term earnings
And then, eventually, this is always our theme that once merchants stay, consumers stay and the retention rate is here and they enjoy the service, we’ll find out ways to monetize. So if you look at the investment we’re making nowadays, we’re actually – this is our decision to invest and to move toward our target. First target is the user base of over 1 billion in China. I think in that aspect, we’re pretty much on track. And then, the multi-app strategy makes the engagement of these users being enhanced. And then, the merchant side, we have a lot going on in terms of merchant service provision, which we’ll also share next month. So the value creation and then eventually we believe the return will be there.
Now that Alibaba has captured a large majority of Chinese AAC, they are building new products and services to unlock new consumption.
Taobao Deals and Taocaicai are serving new niches and growing much faster than Taobao is. There are a whole host of other adjustments that they are making.
Here is Zhang’s full quote for further detail:
Well, if you look at the landscape, actually, today, for e-commerce – for the definition of e-commerce, actually, it’s evolving. So today, in the market, there are multi-formats of e-commerce model. And as long as you have some traffic, you have a user with you and based on the public available third-party payment solution and the logistic and delivery, fast delivery, express deliveries, anybody can try something on e-commerce. But we strongly believe that for Taobao, our advantage is a consumer mindset – and we are purely a consumption destination for all the customers, so we will continue to develop multi-features and applications in our Taobao app at the same time to segment our user group by different mobile apps for specific value propositions.
And today, if you look at the market, I would say, for all the players, actually they are – they may address the customers’ needs from one angle. But actually, for Taobao, we are the only destination who can meet the customers’ purpose from different – to meet the customers’ different purposes. For someone who have very specific shopping purposes, they can – Taobao to them is positioned as a mobile – as a shopping search. And also Taobao has a lot of applications to facilitate people to enjoy the fun of discovery.
And over years, we’ve built of our live streaming business, as well as the short video business and the social contents business. So we are a platform with multi-formats – I mean, consumer journeys for people with different purposes. I think we will continue to invest in this and to give people most comprehensive selections and the most efficient and guaranteed consumer experiences.
It’s not clear to what extent competition vs. macro issues are affecting current or projected revenues
Over the next few weeks, it will be beneficial to examine further how the macro climate in China has impacted Alibaba’s competitors. Again, if they have also seen slowdowns, we know that not all of Alibaba’s lost revenue is because competition has been taking away their business. Knowing to what extent it’s macro vs. competition is hard to know. On the earnings call, an analyst from J.P. Morgan asked specifically about this. Here’s Zhang’s answer:
As to your question about the slower GMV growth reasons, how much cost from macro conditions, how much from the competition. Actually, it’s very difficult to quantify the impact, I would say, so that’s why we believe that these two reasons are all – I mean, are all the factors we should consider. Actually, because we are the market leader in the retail commerce so that’s why I think our performance, to some extent, will reflect the overall market condition.
The large sell-off on earnings day suggests that analysts believe competition is primary culprit. We believe that even if competition is eating away at Alibaba’s business, they will adjust like they always have, and they will continue to ramp up their other growth engines in tandem.
Alibaba Cloud is a hidden gem
We haven’t spoken much here about Alibaba’s Cloud and how it impacts the rest of the picture. The reason it’s not discussed is because it’s growing in a really healthy way and is still a relatively small part of the business. What is pushing the stock price down now isn’t really related to the cloud. What is certain is that Alibaba has a lot of tailwinds. The recent regulation forced Chinese cloud providers to retool their businesses so that data protection is greatly enhanced. This will serve Alibaba well when competing internationally for cloud business. It’s also in the cards that Alibaba take over struggling Tsinghua Unigroup and start producing their own world-class semi-conductors as a complement to their cloud offering.
Disclosure: Long $BABA
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Related Resources
November ‘21 Earnings Recap>
November '21 Earnings Call Press Release, Webcast, and Pres.>
November '21 Earnings Call Transcript>
August '21 Earnings Call Transcript>
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Dudley Glen

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