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Near-Term Concerns Rise for Alibaba, but Wide Moat Intact

Alibaba’s lower-than-expected revenue growth is not a cause for concern as the firm continues to build its network effect, writes Morningstar’s R.J. Hottovy.

The network effect source behind our wide moat rating remains in place following

We are maintaining our $90 fair value estimate, as a modest reduction to our near-term revenue growth forecast will be canceled out by slightly better-than-anticipated adjusted operating profit margin assumptions, though margins are still down year over year due to acquired businesses like UCWeb and AutoNavi as well as ongoing mobile and digital entertainment investments. We expect a five-year compound average revenue growth rate in the low 30s owing to increased spending among online shoppers, a growing user base, and greater mobile monetization rates. Our model still forecasts adjusted operating margins to contract to the mid-30s this year, but grow to the mid-40s over the next five years through greater operating leverage. Shares have traded down close to our fair value estimate today, though we still believe a wider margin of safety is required before taking a position.

One notable development on today's conference call was management's stern rebuttal of a report issued earlier this week by China's State Administration for Industry and Commerce, which criticized the company for not doing enough to police and reduce the amount of counterfeit, illicit, or trademark-infringing products on its marketplaces. Executive vice chairman Joe Tsai made a case that the SAIC report was flawed and based on an "arbitrary methodology" and noted that the company is preparing a formal complaint to the SAIC. Tsai also highlighted the stiff penalties for sellers of counterfeit or illicit goods on its marketplaces. Generally speaking, we believe Alibaba has made progress to improve the integrity of the products sold on its marketplaces in recent years, though we acknowledge that there is still room for improvement, which has been factored into our high uncertainty rating.

Management did not comment on this week's announcement that

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About the Author

RJ Hottovy

Sector Strategist
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R.J. Hottovy, CFA, is a consumer strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is responsible for consumer discretionary and staples research. He has covered the consumer sector as an analyst and director of global consumer equity research for Morningstar since joining the company in 2008, and specializes in a broad range of consumer categories including restaurants, footwear and apparel retailers, consumer electronics retailers, fitness clubs, home improvement and furnishing retailers, and consumer product manufacturers.

Before joining Morningstar, Hottovy was a director and senior stock analyst for Next Generation Equity and an analyst for William Blair & Co., specializing in a wide range of retail and consumer product companies. He also spent two years at Deutsche Bank, covering waste management, water utilities, and equipment rental stocks.

Hottovy holds a bachelor’s degree in finance and a second degree in computer applications from the University of Notre Dame, where he graduated magna cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of Chicago.

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