Alibaba Group (BABA)
Potential rewards outweigh the risks.
What are the key risks and rewards?
Does the valuation make sense?
Is now the time to buy?
I last wrote about Alibaba stock back in October 2020. Since then the shares have fallen over 50%. It’s been a rough 15 months to say the least. Chinese antitrust measures and a souring relationship with Washington have caused Chinese stocks to underperform against the rest of the world. Delisting concerns and a crackdown on Chinese tech have Alibaba investors running for the exit.
JP Morgan analyst Alex Yao has added to the negative sentiment. Yao said that declines in property prices and downsizing in internet firms will put more pressure on consumer spending. He said that although a cut in earnings is largely anticipated it will likely keep the company’s shares pegged down. Even so, Yao appears to be bullish over a longer time horizon.
Investing legend Charlie Munger takes a different view. Munger upped his stake in the company buying another 300,000 shares. Munger has long been an Alibaba bull and has a close relationship with Li Lu, also known as the Chinese Buffett. Lu may have reassured Munger over the crashing stock price.
Looking at the big picture, there’s no doubt that antitrust measures cast a dark shadow. Beijing wants to limit the power of mega corporations like Alibaba particularly as they trial new monetary systems such as Alipay. Putting a dampener on Alipay is bad for Alibaba but sensible for the CCP. Having so many consumers putting money into what is essentially an Alibaba online wallet poses a systemic financial risk.
Chinese crackdowns on tech are also not illogical. Monopolistic practices lead to all sorts of problems such as abuses of power, inequality and disinformation. Western governments such as the US would like to impose similar policies on tech giants like Facebook and Google, if they could only get their policies approved by both sides of the political spectrum.
In the case of Alibaba, there is more to the company than payments. The business is comprised of multiple billion dollar segments that contribute regular injections of cash to the Alibaba coffers. E-commerce, cloud computing, international retail, wholesale and consumer services.
Last year the company brought in $109 billion of revenue, $29 billion of free cash flow and $24 billion of EBITDA. This while the market cap of the company is $312 billion with $71 billion is cash.
Currently, too much negativity is priced in. The Chinese government has successfully advanced capitalism in the past while it has shown itself to be adept at cooling speculative bubbles when necessary.
This is another one of those occassions where the state was to dampen speculation while simultaneously attempting to limit monopolistic practice. For sure, regulations are a net negative for Alibaba. However, Alibaba’s consumer monopoly (and brand) is too entrenched for the company not to do well.
Put another way, the market is roughly pricing in flat growth for Alibaba, despite it’s current dominance and competitive advantages. Too much negativity is priced in and with the Chinese central bank recently cutting interest rates we may be turning the corner.
The issue of shares delisting from US stock exchanges is also more about political rhetoric than it is a major concern for long term investors. Even if Alibaba shares are delisted from the US, investors should face no issues in holding the stock on the OTC markets. Sure, the delisting may negatively affect the valuation multiple for a short period, but this would likely be another opportunity to pick up shares.
Over the longer-term horizon Alibaba should grow at a reasonable rate thanks to the quality of its business offerings and brand. It should also return cash to investors in the form of share buybacks, further enhancing earnings per share and reducing the number of shares outstanding. Share repurchases have already begun with $15 billion of buybacks being instigated in the back end of 2021.
Assuming both of those points, then Alibaba looks to be trading at a favorable level for long term investors. Let’s take another look at the numbers.
Back Of Envelope Valuation
With $71 billion in cash, Alibaba currently trades at an enterprise value of $336 billion. Revenues of $126.37 billion and EBITDA of $24.2 billion mean the company trades at an enterprise value to sales of 2.66 and an enterprise value to EBITDA of 13.91 respectively. Both measures are the lowest they have been since the company went public in 2014. Indeed, the shares are now only a little higher than at IPO, even though cash and revenues have risen 10 x since the IPO.
Alibaba brought in $30 million in free cash flow in 2021 alone. If the company did that every year for the next 10 years it would generate $300 million over that time. Therefore if you buy the whole company today you would essentially be break even in 10 years (assuming no growth).
Now, let’s say Alibaba grows revenues 15% per year for the next 10 years then trades at a slightly higher multiple of 3 times revenue. The company would then be worth around $1.33 trillion giving an investor an annualized return of around 16.6% from today’s prices.
Similarly, if Alibaba grows EBITDA 15% per year for the next 10 years then trades at a multiple of 15 times EBITDA, the company would be worth around $1.28 trillion giving an investor an annualized return of around 16%.
I hope you can see that these numbers are fairly conservative. Since the company’s IPO, Alibaba stock has frequently traded at an enterprise value to revenue of nearer 10 and an EV/EBITDA of nearer 30. The company has averaged revenue growth of 47% over the last five years. Moreover, the company has plenty of cash available for buybacks thereby squeezing the earnings per share.
Let’s say Alibaba in fact grows EBITDA at 20% per annum then trades at a EV/EBITDA multiple of 20. Under that scenario, the company would be worth $2.5 trillion in 2032 which equates to an annualized return of 25% per annum. Remember, this is a company that used to trade at a 30 times multiple.
Alibaba has plenty going for it including huge economies of scale, brand equity and diversified income. Although the stock chart looks ugly, plenty of other metrics are still in upward trends.
Q3 revenues, for example, were 40% higher than Q3 2020 (albeit lower than Q4 2020). The number of active consumers on Alibaba properties also continues to grow hitting 863 million in Q3, up from 757 million a year earlier.
Meanwhile, the company’s revenue sources are significantly more diversified than in the past with significant growth in international services and cloud computing. Chinese GDP growth also came in strong at 8.1% for 2021. This growth could accelerate with increased stimulus from the PBOC and an exit from the pandemic.
As of the time of writing, we believe Alibaba to be a BUY.
As with any investment there are risks to be aware of. We do not know how badly the CCP have it in for Alibaba and we do not know how badly crackdowns will encroach on Alibaba’s long-term profits.
We can’t be sure how long it will take for investors to renew their confidence in Alibaba, if ever, and we understand that Alibaba is an extremely large and complicated business with many tentacles.
However, we see that the tide could easily turn in Alibaba’s favor at any time and feel that the potential rewards outweigh the risks.
Overall, Alibaba shares look cheap trading at the same price as they did in the summer of 2017 and not far from their IPO. Whatever way you look at it, there is plenty of upside available. It’s for this reason that I increased my personal position last week and bought some more shares.
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Disclosure: I/we are long BABA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: This post expresses the opinions of the writer and is for information, entertainment purposes only. Joe Marwood is not a registered financial advisor or certified analyst and does not purport to tell or suggest which securities customers should buy or sell for themselves. The reader agrees to assume all risk resulting from the application of any of the information provided. We strive to provide accurate data and analysis, however, mistakes and errors do occur. Financial investing is risky and not for everyone. You should not bet more than you can afford to lose. We recommend you consult with a licensed financial advisor. Past performance is not indicative of future results.