Alibaba restructuring: A strategy to unlock shareholder value?

Shortly after Jack Ma, the founder of Alibaba Group Holding Limited (NYSE: BABA), emerged in a public appearance, the technology group announced radical plans to overhaul its existing corporate structure. When the news broke on 28 March, shares of the tech giant soared by 14.3% from the prior day’s close. In this article, we examine the underlying reasons for transforming its governance structure and possible outcomes that may impact shareholders.

During the first session of the 14th National People’s Congress, Chinese President Xi Jinping emphasised the importance of China achieving self-reliance in science and technology. The narrative of pushing for an innovation-driven development strategy follows the loosening of a two-year clamp down on the country’s internet sector.

Although Alibaba’s shakeup was not at the behest of Chinese officials, the consecutive actions of Tencent Holdings Ltd (SEHK: 700) and, Inc. (NASDAQ: JD) suggest that trimming their ecommerce empires sit well with regulators. Officially, Alibaba believes that dividing the group into its respective businesses unlocks shareholder value and fosters market competitiveness. Achieving these will certainly require regulatory support from the Chinese authorities, seeing how their supportive stances can shore up the stock markets.

Alibaba splits into six

The restructuring will result in six business units dedicated to cloud computing, commerce (local ecommerce brands like Taobao and Tmall), local services, logistics, digital commerce (overseas ecommerce platforms like Lazada and AliExpress), and media. Each corporation will have its own CEO and board. Chairman and CEO of Alibaba, Daniel Zhang, will continue to hold both roles, on top of heading the Cloud Intelligence Group. Only the highly profit generating commerce segment that generates over two-thirds of total revenue will be retained as a wholly owned entity under the parent group, which oversees the six business units as a holding company. All other units are allowed to raise capital from external sources and pursue their corresponding public listings.

Overall, the announced separation from the parent company resembles a potential carve-out instead of a spin-off or split-off. The difference being that the former involves an initial public offering (IPO) during which shares in the new corporation are sold and can be subscribed by the public. When a spin-off happens, existing shareholders in the parent company are given shares in the subsidiary. And in a split-off, shareholders are forced to exchange existing shares with that of the new entity. This nuance matters because it affects the value of the shares investors receive, due to their differing signalling effects on the markets.

A way to unlock value?

A more detailed look at the structuring may reveal its main intention, one that could debatably reap greater value besides overcoming regulatory scrutiny. Alibaba has been undervalued compared to its peers such as Meituan (SEHK: 3690) and Pinduoduo Inc. (NASDAQ: PDD). Analysts across various brokerage, research and investment firms agree that reorganisation allows Alibaba to finally bridge the valuation gap by unlocking the sum-of-the-parts (SOTP) methodology. SOTP is relevant for companies with distinct business segments in different industries, each having its own characteristics that in turn determine growth rates and valuation.

To illustrate, Goldman Sachs (NYSE: GS) estimated an aggregate per share value of US$137 by way of an SOTP valuation, which still represents a 13.6% premium over its highest year-to-date share price. Historically, carve-outs have proven to unlock value for shareholders of both the parent company and its subsidiaries. In the case of Alibaba, the key focus for investors should probably be on the share price of the parent group post-split given that an IPO is unlikely to happen in the near-term. The company also did not provide an IPO timeline.

If and when one of the resultant corporations does pursue a listing, an option will be to list on the Hong Kong bourse. Following the footsteps of Alibaba, submitted listing applications for its spun-off property and industrial units. The Stock Exchange of Hong Kong (HKEX) is an intuitive choice to list Chinese companies as it represents a gateway for liquidity. New listing rules that support specialist technology companies further make HKEX an ideal destination. The jump in’s share price after its filing spells a bright spark for Alibaba. Naturally, the follow-up question is to ask which business unit will be the first to list. As it stands, the Cloud Intelligence Group and Cainiao Smart Logistics seem to be frontrunner candidates, constituting the second and third largest share of the group’s revenue. These two segments are also hovering around breakeven compared with the remaining segments that continue to rack up losses.

CEO Daniel Zhang further stated the separation primarily aims to improve organisational agility and reduce response time by shortening decision making links. Breaking segments such as its cloud capabilities away from the rest may be beneficial due to more stringent data security requirements. On the flipside, ringfencing business lines may result in greater scrutiny, although this is mitigated by renewed calls for China’s self-reliance in the technology space. The decentralisation will also shave some size off middle and back-office functions.

Moreover, tailored incentive plans lead to better alignment of interests among staff which analysts reckon will create greater ownership, uplift employee morale and thus retention. Finally, given how arduous it is for companies to raise capital needed for sustenance and growth, the ability to curate the pitch for capital and arguably more straightforward due diligence processes (than evaluating a sprawling conglomerate with disparate components) is mutually beneficial. Alibaba is awarded a higher overall value while investors enjoy more flexibility to cherry-pick businesses.

The fifth perspective

A carve-out serves many purposes. From an investor’s perspective, there are two key concerns. The first is whether investor sentiments around Alibaba can be improved to bring about upside potential for holding its shares. The second relates to future buying opportunities in selected parts of the conglomerate and whether their share prices will experience uplifts. Positive shareholder returns arising from a carve-out have been found to be contingent on a full separation between entities that derive performance benefits from a split. Obviously, the quality of execution and timing of equity carve-outs matter too.

Simultaneously, investors should also be aware of the restrictions imposed. A carve-out essentially stifles future attempts by Alibaba to buy back public minority stakes or outright acquire the carved-out entity as doing so will likely destroy shareholder value for both the parent and subsidiary. Thus, even though the proposed split confers more flexibility in some instances, it is important to be cognisant of areas where optionality may be limited.

Tan Ke Xuan

Ke Xuan holds a Bachelor of Business Management from SMU. He identifies as a value investor who prefers to combine both macro and micro analyses when learning about businesses. He believes there are opportunities to be uncovered in every stage of the economic cycle.

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