Alibaba Group Holding Limited
Q2 2018 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Good day, ladies and gentlemen. Thank you for standing by. And welcome to Alibaba Group's September Quarter 2017 Results Conference Call. At this time, all participants are in listen-only mode. After management's prepared remarks, there will be a question-and-answer session. I would now like to turn the call over to Mr. Rob Lin, Head of Investor Relations of Alibaba Group. Please go ahead, sir.

[Robert Lin:]

Good day, everyone, and welcome to Alibaba Group's September Quarter 2017 Results Conference Call. With us are Joe Tsai, Executive Vice Chairman; Daniel Zhang, CEO; Maggie Wu, CFO. This call is also being webcast from our IR section of the corporate website. A replay of the call will be available on our website later today. Now let me cover the Safe Harbor. Today's discussion will contain forward-looking statements. These forward-looking statements involve inherent risks and uncertainties that may cause actual results to differ materially from our current expectations. For detailed discussions of these risks and uncertainties, please refer to our latest annual report on Form 20-F and other documents filed with the U.S. Securities and Exchange Commission. Any forward-looking statements that we make on this call are based on assumptions as of today and we do not undertake any obligation to update these statements, except as required under applicable law. Please also note that certain financial measures that we use on this call such as adjusted EBITDA, adjusted EBITDA margin, adjusted EBITA, adjusted EBITA margin, non-GAAP net income, non-GAAP diluted EPS and free cash flow, are expressed on a non-GAAP basis. Our GAAP results and the reconciliation of GAAP to non-GAAP measures can be found in our earnings press release. With that, I will turn over to Joe.

[Joseph C. Tsai:]

Thank you, Rob. Thank you all for joining us. This quarter, our revenues grew 61%. It is the highest ever revenue growth rate for Alibaba since our IPO. We are demonstrating that Alibaba can deliver high growth at scale. Let me elaborate how – on how we did it. On the last earnings call, I emphasized how important it was to invest for the future. Several years ago, we invested heavily in the key factors that drive today's growth. And let me offer a few specific examples. Number one, we invested in product innovation with new mobile features and content that drive our massive and growing user base in mobile commerce. Number two, we invested in technology to enable us to accomplish algorithmic-driven personalization, which provides great customer experience while delivering increasing uplift in monetization. Number three, we invested in category expansion, resulting in our gaining incremental share in strategic categories such as consumer electronics and FMCG. And number four, we invested in logistics and cloud computing so that our infrastructure of commerce delivers customer satisfaction at scale. Our impressive results demonstrate the importance of investing for the long run. Sometimes long-term investing cuts into short-term profitability. This is where we feel adamant that responsible managers of businesses must choose long-term benefits over short-term results. When we invest for the long term, we not only see financial results come through, we also build lasting franchise value in the business. The manifestation of franchise value include the following

[Daniel Yong Zhang:]

Thanks, Joe. Hello, everyone, and thank you for joining our earnings call today. Once again, we have delivered an outstanding quarter. The robust growth of our business speaks to the unique value proposition that we offer to customers through our strong execution and commitment to innovation. Mobile Taobao continued to reinforce its popularity among Chinese consumers as the preferred online destination for retail discovery and exploration. 549 million users are accessing our China retail marketplaces every month through mobile apps. This increase of 20 million mobile MAUs since June is a fruit of our focus on fostering user engagement through a wide range of content-driven and community-driven mechanisms. Sophisticated real-time personalized product recommendations, subscription-based content and short-form videos all helped to create a stimulating and fun journey for consumers across our retail marketplaces. We are not only meeting the demand of the customers, but also creating the demand. To enhance engagement and the loyalty of our users, we launched a loyalty membership program that offers rewards such as members-only live events and early or exclusive access to products. Our community-driven focus is echoed in the scoring system which incorporates social engagement activity in addition to quality and frequency of their spending. We are pleased with Tmall's ongoing expansion of its leadership position in online B2C sector. Total physical goods GMV grew 49% year-over-year this quarter. We enjoyed robust gains across the board, with accelerated growth in the consumer electronics and FMCG categories. Successful promotional and marketing campaigns have resulted in substantial new customer acquisition to the delight of brands and retailers on our platform. Our retail sorting platform, Lingshoutong, now has more than 500,000 independently-owned mom-and-pop stores in its network. It is empowering our brand partners to gain deeper penetration and insight into their distribution across China. Looking ahead, we remain firmly committed to reinvesting into our Tmall business to drive new user acquisition and promote customer satisfaction. Market leadership and share gain for Tmall will continue to be our priority. This year marks the ninth anniversary of the 11.11 Global Shopping Festival. New Retail will be a new key theme. More than 1,000 brands will be partnering with us to transform 100,000 physical retail locations into smart stores. Our second annual See Now, Buy Now Fashion Show was a broadcasted across several media platforms two nights ago. Our much-anticipated televised annual Countdown Gala will be held in Shanghai this year. We will continue to pioneer new ways to blend effective (10

[Maggie Wei Wu:]

Thank you, Daniel. Hello, everyone. We delivered another very strong quarter. I'll give you some financial highlights. So in September 2017 quarter, major operating and financial metrics continued to record very strong performances. Mobile MAUs on our China retail marketplaces reached 549 million in September, an increase of 20 million over June quarter. Annual active consumers on our China retail marketplace reached 488 million, a net add of 22 million from the 12 months period ended June. Our non-GAAP free cash flow was US$3.4 billion for the quarter. The quarterly revenue growth, very strong, the total revenue grew 61% year-on-year. This was led by robust growth in our China commerce retail business, international commerce, and Alibaba Cloud. We continue to deepen the value proposition of our China retail platform, which is demonstrated in our monetization growth. Our monetization is driven by the interaction of increased consumer engagement and enhanced value to our merchants. Annual revenue per annual active consumer and mobile revenue per mobile user continued its healthy growth in the quarter. Cost of revenue, excluding stock-based compensation, was RMB 20.6 billion. Excluding the effect of SBC, the cost of revenue as a percentage of revenue increased from 34% in the quarter to 38%. So 34% was last year's – last September – and 38% for this quarter. The increase was primarily due to full quarter consolidation of Intime, investments in Hema and Lazada, content acquisition cost for Youku Tudou, and logistic costs relating to Tmall Supermarket. These are areas representing great potential growth we will continue to invest. As a percentage of revenue, without the effect of SBC, all other major operating expenses remained stable or decreased year-on-year, reflecting the operating leverage of our business. Next, non-GAAP net income in the quarter was RMB 22 billion, an increase of 71% year-on-year. Reconciliations of non-GAAP measures to comparable GAAP measures can be found in our press release. Free cash flow. We continue to generate significant free cash flow. In the September quarter, we generated RMB 22.5 billion, or about US$3.4 billion, in free cash flow. Our free cash flow allows us the strategic and operational flexibility to invest in technology and acquire the resources to accomplish our strategic objectives. Since September 30, 2017, our cash, cash equivalents and short-term investments were RMB 160 billion, or US$24 billion. The increase in cash, cash equivalents, and short-term investments during the quarter was primarily due to free cash flow generated from operations, offset by cash used in investing activities, including investments in Ele.me and Tokopedia. Total capital expenditures in September quarter were RMB 8.7 billion, in which about RMB 671 million related to the acquisition of land use rights and construction in progress. Increase here mainly represents our investment in technology, including server, IDC (17

[Operator:]

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. The first question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.

[Eddie Leung:]

Good evening. Thank you for taking my questions. I have two questions. One is on Cainiao. Could you share your thought on the long-term positioning of Cainiao? Again, as the professional logistic service providers in China and globally, how to differentiate and perhaps cooperate in logistics? And then secondly, on New Retail, have we seen any change in the way that we cooperate with some of our brands and merchants across our multiple channels after we developed our offline channel recently? Thank you.

[Daniel Yong Zhang:]

Eddie, this is Daniel. I'd like to answer your questions. For the first one, Cainiao. Actually, Cainiao is positioned as a smart logistic platform. Why smart is because this should be a data-driven logistics platform. We truly believe that the data is the most important asset which can generate value for the partners in the Cainiao ecosystem. And so what we do is that we work closely with our partners in not only warehousing, but also delivery network to enable them to optimize their operation. So we will continue this strategy and which is the partnership strategy and continue to work closely with our partners in China and in the world. And the key thing is that the data-driven logistic network, actually we are – Cainiao is not going to be a logistic company and we are not interested into building another logistics company. Instead, we will work with a lot of logistic companies, delivery companies to build a network across the world. And for your second question, New Retail, I would say actually, our New Retail strategy is very clear and we will continue to execute our New Retail strategy and to partner with the offline retailers in key categories such as in fashion categories, we work with Intime. In consumer electronics, we work with Sony. In food and FMCG categories, we work with Bailian and Sanjiang. And recently, we invest another regional retailer, which is (29

[Eddie Leung:]

Thank you, Daniel.

[Robert Lin:]

Next question.

[Operator:]

Thank you. The next question comes from the line of Alex Yao. Please ask your question, from JPMorgan.

[Alex Yao:]

Hi. Good morning and good evening, everyone. Thank you for taking my question. I have two. One is regarding the strong Tmall GMV growth rate. We understand that last quarter, you guys did some commission revenue rebate to the merchant to incentivize in participating in the discounting and promotion activities. So the GMV growth rate was very strong. In this quarter, based on the financials, I think that you guys didn't do much commission revenue rebates. Then why the Tmall still growing at such a strong rate? And then secondly, regarding your long-term margin profile, I think in the past several years, the margin has been trending down partly because of the investment, partly because of the business model expansion towards more asset-heavy ones such as Hema, Intime, et cetera, et cetera. Do you view these as a temporary transition margin pressure and the longer term, it will revert back to the high platform margin profile as you expand the successful models from Hema and Intime, et cetera, to a wider range of partners? Or do you see this as a philosophical change, to basically increase more asset-heavy model and potentially leading to lower, longer-term margin structure? Thank you.

[Daniel Yong Zhang:]

Hi. This is Daniel again. For your first question, actually we are very happy to see the growth – strong growth of Tmall and, with such large scale, we continue our rapid growth, which demonstrate the strength of our ecosystem. And actually yes, you're right, we didn't give so-called financial rebate to our merchants in this quarter. And I think the revenue growth is driven by, first, about the new customer acquisition, you see that in this quarter, we recorded net adds of 22 million new users. I think that this is very good. And the second is about our – continued to innovate our technology and to personalize the recommendations and user experience, which enable the in-depth product selections matching to the right people at the right place and the third one, I think, the growth is driven by our category strategy and actually, our growth across all key categories. And our merchants are very happy to working with us, because this is – they put – today, most of them fully understand that the power of our platform is not only to help them to sell more products, but also help them to engage new customers and to build their brand. So they are committed to invest more and more resources into our platform. I think that's the key thing, and that's the successful factor of our B2C platform.

[Maggie Wei Wu:]

Right. Alex, regarding your question on the longer-term margin level, I think, when we set our business goal, we're focusing on value position. So we are focusing on the revolutionary reform of the whole supply chain, digitize the offline business, and help the efficiency improvement for merchants, and better consumer experience. So either it's heavy or light, you call it, or higher margin, lower margins, as long as we could provide a value, I think we will surely get the profitability higher, which is much more meaningful to the investors, because all of these investment going to bring in the top-line growth, and then the absolute return on net profit.

[Daniel Yong Zhang:]

Alex, I also want to just address kind of the philosophical question of asset-heavy versus asset-light. I think really, in a business like ours, there's really not a distinction between the – whether you're asset-heavy or asset-light. The metrics that we look at are the efficiency and the productivity of inputs, the inputs of capital and the inputs of people. So if you are getting into an area where you need to deploy a little bit more capital, then we look at the return on invested capital to inform ourselves as to whether we are being efficient. And the same thing is with people, we're constantly improving productivity of our head count. As you can see, we grew revenues over 60%. We did not increase head count by as much, so those are the things that we look at instead of worrying about whether we're asset-heavy or asset-light.

[Robert Lin:]

Next question.

[Operator:]

Thank you. The next question comes from the line of Alicia Yap from Citigroup. Please ask your questions.

[Alicia Yap:]

Hi. Good evening, Joe, Daniel, Maggie and Rob. Thanks for taking my questions. I have two questions. The first one is the big reversal of the commission revenue growth this quarter, just to follow up on the Alex questions. So with the upcoming 11/11 [November 11] in December quarter, how should we be thinking about the commission revenue growth vis-à-vis the Tmall GMV growth? Should we expect some of the divergence happen again, due to the promotional rebate in this seasonally strong quarter? And then second question is related to your international expansions. What type of investment that you plan to spend in the next couple years? Is that – you still need to do a lot more infrastructure investment? Or is it more on acquiring market share which, including further investment into some of the leader positions in certain countries? Thank you.

[Maggie Wei Wu:]

Alicia, in terms of the commission revenue growth, yes, the driver for the growth are the GMV growth for this quarter. And whether we will continue to have the promotional subsidies, we will have it, but not really evenly across these quarters, and not all going to get through by offsetting the commission revenue. So you've seen that we also invested in the marketing, et cetera. International expansion, right now, the investments mainly reflected on Lazada and AliExpress.

[Daniel Yong Zhang:]

Yes, I think we have very clear international strategies, and we are on track. And our current focus is Southeast Asia, and Lazada is a very important investment. And today, we are in the progress – we are in the process of integration and the development of Lazada business. And we will continue to do so as we – as I said during my script. Actually today, we see very clear synergies between the product selections – in-depth product selections in Taobao and Tmall, and the demand from the market in Southeast Asia. And we also have another very important business, which is AliExpress, and they are very popular. They are very popular in some of the emerging markets in Europe. And we are continuing to invest in this cross-border export business and to acquire more and more new customers in other markets. And actually, you raised a very important question, in international expansion, very important thing is infrastructure. And that's why what I'm saying in my script this that we will continue invest in Cainiao. And one of the purposes is to build up a global logistics infrastructure to support the global trading.

[Alicia Yap:]

Thank you.

[Robert Lin:]

Next question.

[Operator:]

Thank you. The next question comes from the line of Piyush Mubayi from Goldman Sachs. Please ask your question.

[Piyush Mubayi:]

Thank you. My first question is to Daniel. Daniel, on New Retail, give us a sense of how quickly your retail partners are embracing this model. And how far are we from this model expanding beyond grocery? Also, how do you think of New Retail impacting online penetration, and from a company perspective, the incremental revenue opportunity? Thank you.

[Daniel Yong Zhang:]

Yes. Today, we work with some of the partners. Actually, we work with our partners in executing our New Retail strategy. Actually, our partners are all believing New Retail because they do understand that they have to embrace Internet. They have to empowered by data technology. So that's why they select Alibaba as their strategic partner. And we are – actually we are working closely with them to, not only to help them to sell more, but also to help them to transform totally digital operations. And today – and we are making a very good progress. And what we will do in the future is to continue to invest and to redefine the retail formats and upgrading our existing retail model to improve the operating efficiency of the retailers. Furthermore, actually most important thing is help them to digitalize the customer management so that they can manage their customers more efficiently rather than just have a brick-and-mortar store and waiting customers to come. So actually, today our long-term goal is to digitalize the whole RMB 30 trillion in social consumption. And compared to that goal, today, we are still in early stage. But we will continue to do so. Thank you.

[Maggie Wei Wu:]

Yeah. Piyush, just to add to Daniel's comments, your question on the New Retail development, one, is it going to be contributing to financially, so you actually can see that starting from this quarter, the New Retail started to have some contribution to our total revenue. Under China retail, there is a line, other revenue, shows 438% growth. That growth includes the consolidation of Intime and Hema. So Intime was not there last year. So even if we take it out, it's still showing very strong growth, it's like around 180% growth. So Hema, our total absolute dollar amount is still small, but you can see that it start picking up. In terms of profitability, again, this is a new initiative. We're not aiming to profitability any time soon. So we focus on expanding the business and the top line.

[Piyush Mubayi:]

Got you. Thank you, Daniel, thank you, Maggie.

[Robert Lin:]

And next question.

[Operator:]

Thank you. And the next question comes from the line of Chi Tsang from HSBC. Please ask your question.

[Chi Tsang:]

Great, thank you very much for taking my question and congratulations on an outstanding set of results. I also wanted to ask you about New Retail. So in particular, as it relates to Intime, I was wondering if you can sort of give us an update or some type of roadmap for integration of Intime. And secondly, as it relates to Hema, what is your growth plan for Hema? I mean, longer term, do you expect Hema to be a major retail chain? Or do you expect more of the growth to come from licensing this New Retail format to other supermarkets? Thank you very much.

[Daniel Yong Zhang:]

We have made great efforts to upgrading Intime model and we are making very good progress. And in Intime, today, we already accomplished the integration of the customer profile. And after this, actually what we can do is that we can track and serve the customers online, offline and anytime, anywhere. People, when they are online and we can integrate – because we integrate the customer profile of Intime and we can target the people actually on the location bases via our Mobile Taobao and the people can buy – either buy from Intime's store on Tmall or we can direct (43

[Robert Lin:]

Next question.

[Operator:]

Thank you. The next question comes from the line of Gregory Zhao from Barclays. Please ask your question.

[Gregory Zhao:]

Hi, management, congratulation on the strong quarter and thanks for taking my question. So my first question about our 88 Membership. So we launched the membership in this quarter. And we connect – I think we connected Taobao, Tmall as well as some Alipay functions. So as we compare this to Amazon Prime membership, Prime membership normally has – the members have stronger consumption intent and higher ARPU contribution. So do we have any initial financial numbers of our loyalty members to share and shall we expect, I mean, broader product offering such as digital content and logistics services in the future? And my second question about recently some headlines about our escalating investment in R&D such as the $15 billion investment in the DAMO Academy. So specifically, what kind of support we expect from this R&D investment to our revenue by business category? And how shall we expect the financial impact from this? Thank you.

[Daniel Yong Zhang:]

For 88 Loyalty programs, this is a new program and we launched in this August. And because we truly believe that the 500 million user base are the most important assets of Alibaba ecosystem. And what we do is try to build up a scoring system among our consumers and each customer have their own score, which is changed per month. And we do give a lot of privilege to our super-members to enhance their stickiness. And as you said, we do see a lot of synergies between different – among different business of Alibaba ecosystem like the synergies between the retail platform and the digital and media platform. And – but we don't want to simply copy the Prime model in – from Amazon to China. I think in China, we can generate our own model and – but we – the purpose of this loyalty customer program is to enhance the stickiness of the loyalty customers and also give people a very clear roadmap how to be loyalty customers and so that we have more and more people to be with us. Our track record shows very clearly that more time people spend with our ecosystem, more time – then they will spend more across more categories.

[Maggie Wei Wu:]

Right. So regarding your question on the US$15 billion spend, this $15 billion is going to be spent over the next three years in the R&D areas for our group. So if you look at the current product development costs we've incurred, which is around 10%, 11% of total revenue, so clearly, we're going to increase the spending in this technology development. I think as a percentage of revenue, our P&D (49

[Gregory Zhao:]

Thank you very much.

[Joseph C. Tsai:]

Sorry, Greg, to your question as to how does the spend – the investment in research and development spread across different business lines, obviously, there are specific businesses that we are dedicating the development investment into, but also, there's a stepped-up effort in general research in fundamental technologies. We see that the next 5 to 10 years is a time period where a lot of these fundamental technologies like deep learning, computer vision, et cetera, areas of artificial intelligence as well as quantum computing, that will really begin to take off and some of the technologies can be applied to actual applications. So the time to invest is now. It is very, very important for us to deepen that commitment to the investment of fundamental technologies. So that's obviously one of the most important factors of establishing research in that area is the acquisition of talent. So we will be bringing on board people that are experts in those areas.

[Robert Lin:]

Next question.

[Gregory Zhao:]

Thank you very much.

[Operator:]

Thank you. The next question comes from the line of Wendy Huang from Macquarie. Please ask your question.

[Wendy Huang:]

Thank you. I have two questions. First, can you give some color on the Lingshoutong? What kind of business model are you trying to build here? And if so, what kind of monetization can you get from those 500,000 mom-and-pop shops in China in the long-term future? And second, for your digital entertainment business, are you seeing any impact from the recent Congress meeting, i.e. any impact for your Q4 revenue there? Thank you.

[Daniel Yong Zhang:]

Lingshoutong is a new business we incubate in the past two years. The purpose of Lingshoutong is to build a data-driven digital platform to enable brand partners to distribute their products to the mom-and-pop stores in low-tier cities, even in rural areas. Traditionally, most of the brands, they have a traditional distribution network, which is sort of a pyramid-like distribution network, layer-by-layer. But via Internet, via digital technology, we can narrow the gap of the layer, and also to keep all the distribution behaviors transparent to the brand. So, via this new model, we want to help the brand to distribute their products to whatever retailers they want, and they can clearly see the sell-in and the sellout. But actually, we don't want to repeat the traditional model, which is, we buy from the merchants or we buy from the brand and we turn around and sell to the pop-and-mom (sic) [mom-and-pop] (53

[Robert Lin:]

Next question.

[Operator:]

Thank you. The next question comes from the line of Youssef Squali from SunTrust Robinson. Please ask your question.

[Youssef Squali:]

Excellent. Thank you so much. Two quick questions for Maggie. On the Cainiao, can you just speak to that $15 billion investment that you've identified? How much of it will you guys be doing directly versus partners, and how will you fund it? And then, on the $4 to $8 billion of renminbi (56

[Maggie Wei Wu:]

Okay. So for the US$15 billion spending in logistics over the next five years, so you get like a 300 – I mean, $3 billion per annum. That is not while spending level – while you see that we increased our guidance by 4%, that's purely adding the consolidation of Cainiao. So you get a – you can derive the revenue level, and then we have disclosed equity pickup of the losses Cainiao incurred. So their current spending level is already there. If you analyze it, it's already somewhere around $2 billion. So the spending going to be both in CapEx and OpEx, but (57

[Youssef Squali:]

Right. The $4 to $8 billion (57

[Maggie Wei Wu:]

Right. Okay. So you've seen that we've reported two quarters now and – very strong growth. And we currently have not adjusted our revenue guidance for the business, excluding Cainiao. So that's because, first of all, the guidance I gave during the Investor Day was already a very high guidance, actually. So that was 10 percentage points than – higher than consensus by that time. So we're very well on track to achieve that high goal. Secondly, as I mentioned, we had this personalization algorithm launch last September and now we get to the anniversary of that change. So in December quarter, we're going to no longer have the easy comps And thirdly, if you look at the December quarter, it's going to be a big quarter. So the large events like Singles' Day and et cetera. So this may impact the revenue, we would rather wait and see. We do believe that we'll continue to have that technology enhancement, et cetera. But people shouldn't just assume our technology growth linear over quarters.

[Robert Lin:]

Youssef. I just want to add to what Maggie said. So essentially, what we outlined at the investment (59

[Youssef Squali:]

Great. Thank you.

[Robert Lin:]

I think that will be the last question.

[Operator:]

Thank you. The next question comes from the line of Thomas Chung from Credit Suisse. Please ask your question.

[Thomas Chung:]

Hi. Thanks, management, for taking my questions. I have a couple of quick questions. The first one is about our content strategy. Is there any plan to monetize the front page in the medium term? And my second question is about, is there any expectation in terms of the GMV, the 11.11? And finally, can management give us some color about the number of call (01

[Daniel Yong Zhang:]

Actually, for your first question, on our core commerce business, we are, actually execute a very clear strategy in content-driven and community-driven Mobile Taobao. And following this strategy, actually, we add more and more contents in different formats, in short form video, in news feeds, in recommendations to our customers, and we receive very good feedback from customers. That's why we got very good stickiness of the customers. And – but we are very – actually, as we always do, we don't try to monetize all this new traffic immediately. Instead, we try to improve the user experience and improve our algorithm to meet the users' demand. But going forward, we do see some potentials to monetize the value of these contents. But we are not in a hurry to do that.

[Robert Lin:]

Operator, that's the last question.

[Operator:]

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you all for your participation. You may all disconnect the lines now. Thank you.