BABA Seven Shareholder Lawsuits and an SEC Inquiry, Six Months After the IPO

The Flywheel Alibaba Doesn't Fully Own

Alibaba's China retail marketplaces run on a simple loop: more buyers and sellers → more Gross Merchandise Value^» (GMV) transacted on Taobao Marketplace and Tmall → more revenue from the sellers who pay for online marketing placement and, on Tmall, a transaction commission → more reason for buyers and sellers to show up next quarter. That loop is real and it's the engine behind this quarter's headline growth. But the loop's most important adjacent business - payments - isn't inside Alibaba at all.

Alibaba divested Alipay in 2011, spinning it out to a company now called Ant Financial Services, majority-controlled by founder Jack Ma through a vehicle called Hangzhou Junhan Equity Investment Partnership ("Junhan"). Alibaba doesn't own Ant Financial. What it has instead is a contract: since an August 2014 restructuring, Alibaba is entitled to an expense reimbursement plus 37.5% of Ant Financial's entire consolidated pre-tax income, described in the filing as a "perpetual" arrangement. So every dollar the flywheel pushes through Alipay - 75% of all GMV on Alibaba's China retail marketplaces was settled through Alipay in the twelve months ended March 31, 2015 - eventually shows up in Alibaba's own income statement as profit-share income, even though Alibaba doesn't consolidate Ant Financial's balance sheet, doesn't control its board, and structurally can't (Chinese rules on foreign ownership of payment and internet-content businesses are the entire reason Alipay was spun out through a Variable Interest Entity^» (VIE) structure in the first place - the same structural workaround Alibaba still uses for its own China licenses).

This is Alibaba's first annual report as a U.S.-listed company, covering the fiscal year ended March 31, 2015 - the year in which it completed its September 2014 initial public offering on the NYSE, at the time the largest IPO in history, on any exchange. Alibaba priced at US$68.00 per American Depositary Share^» (ADS), and after the underwriters' over-allotment was exercised in full the same day, raised US$10.0 billion in net proceeds for the company (a larger amount again went to selling shareholders, including Yahoo). The stock's own first year as a public security tests whether the ecosystem behind that IPO price is as durable as the loop above suggests, or whether some of what makes the loop turn - a founder-controlled counterparty, licenses held through contracts rather than ownership, a regulator that had flagged the platform for counterfeit goods weeks before the IPO priced - is exactly the kind of thing a skeptical read of the fine print exists to catch. See Beyond the Usual below for what that read turned up.

The Prescription

Alibaba's mobile shift is real and mostly a tailwind - mobile monthly active users hit 289 million in March 2015, up 77% from 163 million a year earlier, and mobile GMV crossed 50% of total GMV for the first time this quarter. The company should keep pushing users toward mobile, because that's where its actual usage growth is - but it needs to close the monetization gap that comes with it, not just accept it. The China retail marketplaces' overall monetization rate actually fell this year, from 2.55% to 2.44%, explicitly because mobile GMV monetizes at a lower rate than desktop. Winning the platform shift and losing yield on every dollar that shifts is not a stable trade forever; the mobile ad and commission product needs to catch up to where desktop already is, not be treated as an acceptable-for-now discount.

What it should stop doing: using the company's own balance sheet to facilitate a founder's personal investments. In a transaction disclosed as both a related-party item and a subsequent event, Alibaba pledged RMB7.3 billion of its own invested assets as collateral for a RMB6.9 billion bank loan to founder Simon Xie, so he could fund a personal minority stake in a Shenzhen-listed media company - and then separately agreed to lend Xie up to RMB2.0 billion more to cover the interest on that very loan (see Beyond the Usual). None of this is share-price-moving on its own, but a public company six months removed from its IPO shouldn't be in the business of underwriting a founder's side investments with shareholder assets. That's a boundary a newly public company should draw brightly, not blur in a footnote.

Key Financial Metrics

Fiscal year ended March 31, 2015 vs. fiscal year ended March 31, 2014

FX: RMB 6.1990 = USD 1.00 (March 31, 2015, per the company's own filing).

Metric	FY2015 (RMB)	FY2015 (USD)	FY2014 (RMB)	YoY
Revenue	76,204M	$12,293M	52,504M	✅ +45.1%
Cost of revenue	(23,834M)	($3,845M)	(13,369M)	⚠️ +78.3%
Gross profit (derived)	52,370M (68.7% margin)	$8,448M	39,135M (74.5% margin)	⚠️ Margin -5.8pp
Share-based compensation (in opex, all lines)	13,028M	$2,102M	2,844M	⚠️ +358%
Operating income	23,135M (30.4% margin)	$3,732M	24,920M (47.5% margin)	⚠️ -7.2%, margin -17.1pp
Net income	24,320M	$3,923M	23,403M	✅ +3.9%
Net income attributable to ordinary shareholders	24,149M	$3,896M	23,076M	⚠️ +4.6%
Diluted EPS / ADS	RMB9.70	$1.56	RMB10.00	⚠️ -3.0%
Net cash from operating activities	41,217M	$6,649M	26,379M	✅ +56.2%
Capex (property/equipment + land use rights)	7,705M	$1,243M	4,776M	⚠️ +61.4%
Free cash flow (derived: op. cash flow − capex)	33,512M	$5,406M	21,603M	✅ +55.1%
Cash and cash equivalents	108,193M	$17,453M	33,045M	✅ +227%
Short-term investments	14,148M	$2,282M	10,587M	✅ +33.6%

Balance sheet	Mar 2015 (RMB)	Mar 2015 (USD)	Mar 2014 (RMB)	YoY
Total assets	255,434M	$41,206M	111,549M	✅ +129%
Total liabilities	97,363M	$15,707M	70,731M	⚠️ +37.6%
Unsecured senior notes (new this year)	48,994M	$7,903M	—	New
Mezzanine equity (Convertible Preference Shares etc.)	658M	$106M	10,401M	✅ -93.7% (converted at IPO)
Total Alibaba shareholders' equity	145,439M	$23,462M	29,338M	✅ +396%

Revenue grew 45% - a genuinely strong year for the underlying business. But net income attributable to ordinary shareholders grew only 4.6%, and diluted EPS actually fell 3%, because cost of revenue nearly doubled and share-based compensation jumped 4.6x to RMB13,028 million, most of it tied to equity awards vesting around the IPO (see Beyond the Usual). Operating margin compressed from 47.5% to 30.4% in a single year. None of this is fabricated or hidden - it's all in the audited statements - but a reader looking only at the 45% revenue headline would badly misjudge how much of that growth reached the bottom line. Alibaba's 20-F doesn't report an "Adjusted EBITDA" figure (that non-GAAP framing came in later fiscal years) - operating income is the closest GAAP line, and it's the metric that actually shows margin compression the revenue number hides. Total assets and equity both exploded, almost entirely because of the IPO itself: US$10.0 billion of net proceeds, plus a new US$8 billion-equivalent unsecured senior notes issuance (RMB48,994 million/$7,903 million outstanding at year-end), pushed cash and short-term investments to RMB122,341 million ($19,735 million) from RMB43,632 million a year earlier.

A 45% revenue year that only grew the bottom line by single digits is a margin story, not a growth story - and the gap is almost entirely the cost of going public.

Key Operational Metrics

• Total GMV, China retail marketplaces: RMB2,444 billion ($394 billion) in fiscal 2015, up 46% from RMB1,678 billion in fiscal 2014 - Taobao Marketplace GMV grew 36% to RMB1,597 billion and Tmall GMV grew a faster 68% to RMB847 billion, meaning Tmall (the paid, commission-generating marketplace) is gaining share of the mix, structurally positive for monetization even though it didn't show up in the blended rate this year.
• Monetization rate (China retail marketplaces): 2.44% in fiscal 2015, ⚠️ down from 2.55% in fiscal 2014 - explicitly attributed by the company to mobile GMV's lower monetization rate as mobile's share of the mix grew.
• Mobile GMV as % of total GMV: crossed 51% in the quarter ended March 31, 2015 (the first quarter it exceeded half), up from 42% the prior quarter and 27% a year earlier.
• Mobile monthly active users: 289 million in the month of March 2015, ✅ up 77% from 163 million a year earlier.
• Annual active buyers (trailing twelve months): 350 million as of March 2015, ✅ up 37% from 255 million a year earlier - management attributes most of the GMV growth to this buyer-count increase rather than higher per-buyer spending.
• Active sellers: over 10 million on the China retail marketplaces in the twelve months ended March 2015 - not available as a prior-year comparable figure in this filing.
• Mobile revenue, China commerce retail: RMB17,840 million ($2,878 million), 30% of China commerce retail revenue in fiscal 2015, up from just 7% (RMB2,905 million) a year earlier - a genuinely fast internal shift, even though it's monetizing at a lower rate per the point above.

Beyond the Usual

Seven shareholder class actions and an SEC inquiry, inside Alibaba's first year public

On January 30, 2015 - four months after the IPO - Alibaba was named defendant in the first of seven putative shareholder class action lawsuits (filed in the Southern District of New York and two California federal districts, later consolidated in New York), on behalf of ADS holders who bought between October 21, 2014 and January 28, 2015. The complaints allege Alibaba's IPO registration statement and prospectus misrepresented its business and failed to disclose a July 16, 2014 "administrative guidance" meeting with China's State Administration for Industry and Commerce (SAIC) - a meeting later the subject of a SAIC "white paper" (self-described, and withdrawn the same day it was released) criticizing the platform's handling of counterfeit goods. The same day the lawsuits began, the SEC opened a non-public inquiry into whether federal securities laws were violated, requesting - and receiving - Alibaba's voluntary cooperation on background facts related to the SAIC interaction. Neither the class actions nor the SEC inquiry had been resolved as of this filing; the company states it can't estimate any possible loss.

A luxury-brand lawsuit over counterfeit goods, filed weeks after this fiscal year closed

On May 15, 2015, Gucci, Balenciaga, Bottega Veneta, Yves Saint Laurent and parent company Kering sued Alibaba in the Southern District of New York, alleging the company knowingly supported the sale of counterfeit merchandise on its marketplaces. This isn't a background risk-factor mention - it's a filed lawsuit from name-brand luxury plaintiffs, disclosed in this same annual report, that directly echoes the SAIC counterfeit-goods criticism referenced in the securities litigation above. Two entirely separate legal actions - one from shareholders, one from luxury brands - both point at the same underlying question about marketplace integrity, in the same fiscal year Alibaba went public promising a "trusted ecosystem."

A founder's personal investment, financed through the company's own balance sheet

In May 2015, Alibaba pledged RMB7.3 billion of its own invested wealth-management-product assets as collateral for a RMB6.9 billion bank loan extended to founder Simon Xie, financing his personal minority investment (through a PRC limited partnership, co-controlled by Jack Ma's own vehicle) in Wasu, a Shenzhen-listed digital media company. Alibaba separately agreed to lend Xie up to RMB2.0 billion more, specifically to cover the interest on that same bank loan. The company frames this as strengthening its entertainment-sector relationships; it's also a public company using its own treasury to backstop a founder's side investment and then lending him money to service the resulting debt.

The economics of a business Alibaba doesn't consolidate

Since an August 2014 restructuring, Alibaba's contract with Ant Financial Services entitles it to expense reimbursement plus a perpetual 37.5% share of Ant Financial's entire consolidated pre-tax income (up from 49.9% of Alipay alone under the original 2011 arrangement, but now covering all of Ant Financial's businesses, not just Alipay). Alibaba recognized RMB1,667 million ($269 million) of this profit-share income in fiscal 2015. Separately, Alibaba retains an option - subject to Chinese regulatory approval the company itself calls unlikely under current rules - to eventually buy up to a 33% direct equity stake in Ant Financial, or take a one-time payment equal to 37.5% of Ant Financial's equity value if that never happens. Either way, one of the two businesses at the center of Alibaba's whole flywheel isn't something Alibaba owns or controls - it's something Alibaba has a very well-drafted contract with.

The largest single cash cost tied to Ant Financial isn't the profit-share income - it's payment processing

Alibaba paid RMB3,853 million ($622 million) to Alipay for payment processing services in fiscal 2015, up from RMB2,349 million the year before - by far the largest cash flow between the two companies, and one that runs the opposite direction from the profit-share income highlighted above. Alibaba also sold its own SME micro-loan business to Ant Financial in February 2015 for RMB3,219 million ($519 million) cash, retaining only a small wind-down portfolio (RMB835 million/$135 million remaining at year-end).

The VIE structure holding up a chunk of the flywheel

Because Chinese law restricts foreign ownership of internet-content, payment, and telecom-licensed businesses, Alibaba (a Cayman Islands company for these purposes) operates parts of its China business - and Ant Financial operates entirely - through Variable Interest Entities: businesses legally owned by Chinese nationals (often company insiders) that Alibaba controls only through contracts, not equity. The company states its own opinion that this structure complies with current PRC law, but explicitly discloses it has "no assurance" regulators will always agree, and that an adverse view could force restructuring or deconsolidation. RMB26,902 million of net assets held in PRC subsidiaries and VIEs were restricted from being paid out to Alibaba as dividends as of this year-end.

A 4.6x jump in stock compensation, mostly a one-time IPO artifact

Share-based compensation expense hit RMB13,028 million ($2,102 million) in fiscal 2015, up from RMB2,844 million the prior year - the single biggest driver of the operating-margin compression in Key Financial Metrics above. RMB3,788 million of that total is a separate, unusual item: share-appreciation awards linked to Ant Financial's valuation, granted to "most" Alibaba employees by Junhan (Jack Ma's Ant Financial holding vehicle) and settled in cash by Junhan, not Alibaba - a real compensation cost for Alibaba's workforce that the company describes as carrying no economic cost to its own shareholders, even though it shows up as an expense on Alibaba's own income statement.

The IPO cleaned up two messy balance sheet items at once

The Convertible Preference Shares that had complicated Alibaba's balance sheet since 2012 (RMB10,401 million of mezzanine equity at the start of the year) automatically converted to 91,243,312 ordinary shares at the IPO, and the Yahoo Technology and Intellectual Property License Agreement - which had cost Alibaba a royalty of 1.5-2% of consolidated revenue every year since 2005 (RMB448 million in this fiscal year alone, for the pre-IPO months it still applied) - terminated the moment the IPO completed. Both are genuinely good-news footnotes, not criticisms; a public listing removed two real, recurring costs of being privately held.

Checked and found nothing further notable this fiscal year beyond what's covered above: no additional undisclosed litigation, no dilution/pledge concerns beyond the Simon Xie item, and no management churn (the CEO and CFO named in the securities litigation above remained in their roles through this filing).

Target Valuation Range

~$207.7 billion market capitalization at a ~53.4x trailing P/E - priced for a decade of dominance, not for the year it just had. On a year where net income to ordinary shareholders grew only 4.6%, the market isn't pricing this quarter's numbers - it's pricing the flywheel holding up, the mobile monetization gap closing, and Ant Financial's profit share continuing to flow, all without a hiccup on any of the litigation above.

Alibaba's ADS closed at $83.24 on March 31, 2015 (the quarter's period-end), against 2,495,499,036 ordinary shares outstanding at that date. Alibaba has not split its NYSE-listed stock since this IPO, so this is the actual nominal price quoted at the time. The stock priced at $68.00 at IPO (September 19, 2014), rallied to a monthly close of $111.64 by late November 2014, then declined through the SAIC/litigation controversy covered in Beyond the Usual to close the fiscal year at $83.24.

Market cap → enterprise value	FY2015 (ended Mar 31, 2015)
ADS price (period-end)	$83.24
Shares outstanding	2,495,499,036
Market capitalization	~$207.7B
Total debt (unsecured senior notes)	$7,903M
Less: cash and short-term investments	$19,735M
Enterprise value	~$195.9B

Peer-multiple sanity check	FY2015
Diluted EPS	$1.56
Trailing P/E	~53.4x (~49.8x on basic EPS of $1.67)
Book value/share	~$9.40 (equity $23,462M ÷ 2,495.5M shares)
P/B	~8.9x
Revenue	$12,293M
EV/Revenue	~15.9x

This is Alibaba's first annual report as a public company, so there's no prior-quarter comparison yet. All three multiples are rich by any normal standard - but Alibaba isn't a normal-growth business at this point: 45% revenue growth, a dominant and still-growing marketplace position, and a payments-adjacent profit stream (Ant Financial) that doesn't even sit on its own balance sheet. The multiple is a bet that all of that keeps compounding faster than the operating-margin compression this year's numbers already show.

DCF (base/bull/bear, illustrative only): A rigorous multi-year DCF isn't something one fiscal year of data as a public company supports responsibly - this is Alibaba's first annual report, so there's no trailing multi-year FCF trend to anchor projections to yet.

Scenario	Key assumption	Implied value
Current (FY2015 close)	actual market price, for reference	$83.24/ADS (~$207.7B market cap)
Bear	mobile's monetization gap doesn't close (the rate that fell from 2.55% to 2.44% this year keeps falling as mobile GMV keeps growing), the SAIC-linked litigation produces a real loss or reputational hit, and margin compression from cost-of-revenue and comp growth continues	~$23.40/ADS (~$58.4B market cap) - multiple compresses to a mid-teens P/E (15x) on this year's $1.56 diluted EPS, more typical of a mature, slower-growing internet company
Base	revenue growth moderates from 45% but stays well above 20% for several more years, mobile monetization gradually catches up to desktop, and the litigation resolves without a material loss	≈$83.24/ADS (~$207.7B) - current ~53.4x multiple holds roughly flat as earnings grow into it
Bull	GMV growth (46% this year) and buyer growth (37% this year) continue at a similar pace, Tmall's higher take rate keeps gaining share of the GMV mix, and cloud computing becomes a second major growth engine	≥$83.24/ADS (≥~$207.7B) - justifies today's multiple or better

Reverse DCF: To justify the current ~$207.7 billion market cap purely on today's fundamentals within a normal DCF horizon, free cash flow (roughly $5.4 billion this fiscal year on the derived operating-cash-flow-minus-capex basis) would need to compound at a very high rate for many years running - directionally consistent with what a 45%-revenue-growth, still-early internet platform needs to deliver to earn its multiple, but a real distance from what a single year of 4.6%-bottom-line growth has actually proven yet.

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