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By R.J. Hottovy, CFA | 10-24-2014 10:00 AM

What We'll Be Watching in Alibaba Earnings

We expect strong top-line growth but, in the near term, contracting margins for the wide-moat e-commerce firm.

R.J. Hottovy: With Alibaba's (BABA) IPO taking place just about a month ago, we think it's now time to take a look forward at the company's first quarterly earnings results, which will take place the morning of Nov. 4, before the market opens.

Generally speaking, we expect very strong top-line growth out of Alibaba with revenue expected to exceed 50% during the quarter. This is going to be fueled by a number of drivers, first being the increased number of active users, which we think might actually exceed 300 million users for the quarter.

We also think that we will see an increase in the engagement level among active users, fueled by wealth creation in China as well as a wider assortment of offerings across the different Alibaba platforms. That being said, we do expect margins to contract this quarter, both gross margins and operating margins, as the company makes several investments on a number of fronts. These include its own mobile platform, its increased marketing spend, some new content deals, as well as its own international-growth aspirations. We expect this to take gross margins to approximately 72%--down from 75% a year ago--and operating margins to about 42.6%--down from 47.5% a year ago.

Now, looking beyond this quarter and over the next five years, what should investors expect from both a revenue and an operating-margin perspective? We expect that revenues will naturally decelerate from its 50% growth in 2014 and eventually fade to the mid-teen range over the next five years. That's just a result of the law of large numbers as the company naturally grows into its base.

From a profitability standpoint, we do expect that 2014 will effectively be one of the low watermarks for the company over the next five years. We expect the company to build scale advantages over the next couple of years, with gross margins approaching 75% and operating margins approaching 48%. So, longer term, we think that the growth story is still pretty compelling, and we think this is one of the most scalable models in the e-commerce space today. So, even with the downturn in margins that we expect out of this quarter, we do think this is one long-term story for investors to keep on their radar screen.

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