alibaba investment overview 81314 rlc

Investment Overview Alibaba (Ticker: BABA (NASDAQ))

“Connecting China, The Internet and Soon The World”

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“Confidential” Note: For Equity Syndicate Use Only

Columbus Advisors Group 8/5/14

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Investment Rationale/Valuation Assessment

The results of our probability-weighted “DCF” analysis values BABA at $91/ADS,

+44% above the mid-point.

We expect the ADS’s to price at the “high-end of the range and possibly above (a

delicate balance given the Facebook experience…). Assuming “normal” market

conditions, we believe BABA will trade at “fair value” within 3-6 months. We would

assign an "above-average" economic moat to BABA given its “visionary” and passionate”

founder, its competitive position (including BABA’s “healthy” level of respect for the

competition….”) in the industry and its strong free cash flow generation. We hold our

views despite the obvious concerns re: corporate governance, organizational structure

and the competitive intensity in the space. Other names such as Baidu, Tencent and

Vipshop, provide great examples of companies that have executed (despite such),

producing attractive returns. Further, we do not expect the issues surrounding Alipay or

the media investment to derail the shares. Finally, we could be witnessing the making of

a “hero” for the little guy. If there is a concern it’s the technicals1 (certain indices won’t

participate and ESG funds unlikely to participate…) and the trade wars between the U.S.

and China.

China has historically built and protected champions under the theory that a few large

competitors are easier to police, than multiple smaller concerns. While that could

change in the future, BABA will likely spread it wings West. Moving from an “export-led”

economy to one of “consumption” should also serve BABA well. Historically BABA has

experienced solid financial performance. Though revenue growth is expected to

moderate given the law of large numbers (a fact discounted in our model).

Creating Value

Keys to creating long-term value for shareholders are the equity support provided by

long-only accounts (large indices restricted from holding shares), response to rising

competition, investors discounting probability of trade wars (China’s recent targeting of

Technology and Industrial concerns…), mobile monetization, product authenticity,

capital allocation (there is capacity for a dividend…levered would be just fine)

and, the management of regulatory risk, both US and China (see below for more

details).

Recent performance in Chinese equities has been mixed vs. the broad S&P indices.

1 BABA has assigned a 6% position for “Friends and Family,” supporting his views on looking out for the

“little guy”



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Near-term outperformance could be mitigated by “negative” sentiment towards

auditing/accounting and corporate governance related to China-based operations.

Financial Model Results

Our approach - We employed a “DCF” model to value BABA.

- We modeled three years, sensitizing our “base case” results.

- Key variables include: 1) discount rate, 2) revenue growth, 3) margins and 4)

capital intensity.

- Upon completing the scenario analysis, we calculated an “expected value” or

“probability-weighted” price target.

BABA comfortably produces a growing level of discretionary cash. Given the low level of

debt, the company’s cost of capital is quite onerous. We believe that the company will

tap the “public debt” markets to not only reduce its WACC, but also to access an

alternative source of financing (establishing a credit rating – likely “A-“ or

better2…the average “A-rated” credit is placing “intermediate” paper at a 2.89%

yield). We view the latter as prudent as BABA “optimizes” its capital structure on a

“global” stage.

While BABA has debt (largely bank debt) on its balance sheet, its cash and equivalents

put the company in a “net cash” position. A dividend is not expected at this time, but

clearly the company has dividend capacity.

Earnings Quality (Average) – Barter transactions and swings in “non-cash” items are a

cause for concern.

Historical Cash Flow Production - Historically comfortably free cash flow positive, low

capital intensity supports such.

Why We Like the Offering

- Valuation – The initial price range is well within our probability-weighted target;

- Scale/Target Market/Platform – BABA is the largest online and mobile

commerce company in the world in terms of GMV (Gross Merchandise Volume…).

Asset light business model;

2 BABA employ’s an asset securitization program to supplement is cash flow generation (S-1)



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- Visibility/Profitability/Granularity – Solid double-digit revenue growth and

cash flow generation. BABA’s service offering is the “life-line” for individuals and

SMB daily;

- Trends – Monetization of traffic on mobile platform; China’s Internet penetration

level;

- Financial Risk/Free Cash Flow – Net cash position3 and solid FCF yields

throughout our forecast. Low capital intensity provides the basis for solid and

sustainable free cash flow production;

- Sponsors – Softbank a visionary organization and “strategic” investor;

- Management – Competent management. Jack and his deemed did an

“excellent” job delivery the company and its vision at the IPO lunch. In China,

Jack Ma is the equivalent of a “rock star” in the U.S.

Earnings / Cash flow Vulnerabilities

Vulnerability Probability Impact

Key Man Risk – Jack Ma Low High

Security Breaches/Identity Theft Risk Average High

Working Capital Management Risk (includes factoring receivables) Average High

Corporate Gov.4/VIE/Conflicts-of-interest/Cayman Domiciled5 Average High

Regulatory Risk – PRC (China considering tax for on-line services) Average High

Accounting6/Audit Requirements Risk Average High

Integration and Investment Risk High Average

Competition/Execution (Holding Co. Structure) Risk High Average

Other Commentary:

Regulation/Corporate Governance/VIE Structure – Under the PRC, foreign shareholders

have “rights” to the earnings stream vs. equity ownership in assets based in China

(hence “VIE” or “Variable Interest Entity” structure – Technology and Communications

related assets in particular…). Further, if infractions or missteps occur, the PRC has the

option of stripping valuable assets from Alibaba shareholders, resulting in a significant

impairment of equity value.

Accounting7 – China and the US are in public disagreement re: the provision (and

3 Alibaba has access to an $8B libor-based credit facility which could be fully drawn at any time, exposing the

company to “repricing” risk (mitigated by good cash flow) 4 Partnership controls the Board vote as opposed to “traditional” independent directors (S-1) 5 The Cayman Islands has a less developed body of securities laws than the US and provides significantly less

protection to investors (S-1) 6 As a “foreign private issuer,” Alibaba is not required under the Exchange Act to file periodic reports and

financials with the same frequency and promptness as SEC registered entities (S-1) 7 Note that certain PRC companies enjoy preferential tax-treatment and Alibaba is no exception, the

companies effective tax rate was 9.9% as of 12/31/13



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review) of “China-based” CPA affiliates, of US accounting firms working papers, by US

regulators.

Business Summary

BABA is the largest online and mobile commerce company in the world in terms of gross

merchandise volume in 2013, according to the IDC GMV (Gross Merchandise Value)

Report. BABA operates its marketplaces as a platform for third parties, and does not

engage in direct sales, compete with merchants or hold inventory.

China has some 618MM Internet users, more than twice the U.S. An estimated 53MM

Chinese logged onto the web for first time, in 2013. Though less than 50% have web

access, supporting significant upside for BABA.

Key June 2014 metrics (year/year)

+46% revenue

+26% operating income

+60% adjusted net income

+74% free cash flow Key Shareholders (pro-forma ownership)

- Soft-bank (32.4% - Not selling any shares)

- Yahoo (16.3% - Selling 140MM shares or $5B in value)

- Jack Ma (7.8%)



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Comps and Related Performance

Performance Performance

Thru 8/21/14 Thru 9/10/14

L3 Months Last Month

China E-commerce/Search

TCEHY -6.87% 15.10%

BIDU 2.60% 27.25%

CMCM 11.62% 91.61%

JD -0.04% 41.20%

JMEI -21.76% 37.68%

VIPS 10.84% 27.65%

QIHU -14.15% -1.72%

US e-commerce/social media

EBAY -5.83% 8.02%

FB 5.98% 27.75%

The Cloud/Big Data

NOW 13.16% 10.64%

CRM 11.50% 9.60%

DATA 21.13% N/A

Big Retail

WMT 2.46% N/A

AMZN 4.59% 10.41%



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The Mobile Evolution

alibaba investment overview 81314 rlc

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