It's not an easy time to be an investor in Alibaba (BABA 0.11%) as it faces several issues, such as slower growth and a crackdown by the Chinese government.
Lately, however, the management team announced a radical move to get the company back on track -- and that's by breaking the giant Alibaba into six baby Babas.
This unexpected move could be game changing for a couple of reasons.
Image source: Getty Images.
More autonomy could lead to better execution
Alibaba was a star among growth investors for years after it went public in 2014 thanks to its hypergrowth profile -- it grew revenue by over 30% annually for years (and even more than 50% in some years).
Lately, however, things were not as rosy. Revenue grew just 19% in its fiscal 2022 (ended March 31, 2022) -- and by just 2% in the first nine months of the fiscal 2023. While there were many contributing factors, Alibaba's sheer size was a massive drag on its performance.
Thanks to its early success in e-commerce, the tech conglomerate ventured into related industries like fintech, cloud computing, logistics, entertainment, and others. Many of these businesses, such as Ant Group, Ali Cloud, and Cainiao, became very successful and have become giants in their industries.
Alibaba's success, however, means that it is becoming increasingly more difficult for its leadership team to cover the scope of its sprawling empire. So as Alibaba grew, management had to make more decisions and manage more businesses and people -- leading to slower decision-making and weaker accountability.
By breaking down these business units now and potentially listing them separately, Alibaba is giving its "children" the freedom to chart their own paths. Doing so could lead to a better focus, faster response to changes, better incentives, and more. More importantly, this move could bring back the entrepreneurial spirit that Alibaba needed so badly to compete against rivals, such as Pinduoduo and Douying in e-commerce and Meituan in local services.
Shareholder value could improve
Alibaba's massive (and diverse) business empire also made it difficult for investors to understand and, more importantly, value.
For example, although it has many younger and faster-growing segments, Alibaba's China e-commerce business was the only profitable segment. But as the young ventures were unprofitable, Alibaba's reported profits would inevitably be lower after accounting for these losses. So a less-informed investor might value the whole conglomerate lower than just the stand-alone e-commerce business.
Besides, while these younger ventures were unprofitable -- and thus cannot be valued using metrics like price-to-earnings (P/E) ratio -- they still commanded specific valuations. For example, the logistics arm Cainiao grew revenue at 27% recently but reported an operating loss. So for this business, it might be more appropriate to value it using metrics like the price-to-sales (P/S) ratio.
By separating these segments, Alibaba makes it much easier for investors to understand the different parts of the company. From there, industry-specialized analysts can better value each component using the appropriate methods, leading to better value discovery.
Also, investors with different objectives can choose which subsidiary to invest in instead of the parent company. Growth investors might choose Cainiao, whereas value investors might be inclined to focus on Taobao and Tmall. Ultimately, this would all likely create more value for existing shareholders.
What it means for investors
Once an investor darling, Alibaba has fallen from grace as it faced various problems amid its gigantic size. Hence, the management team's recent strategic move could be just the medicine needed to get the company back to its past glory.
Still, investors should not get overly excited just yet. It is still very early days, and it will take a while to understand the actual impact of such a move. It's best to keep an eye on Alibaba over the coming months to get an early indication of how this process could unfold over time.
