Alibaba: Revisiting The Investment Thesis. Still A Strong Buy. (NYSE:BABA)

Introduction

It seems nothing can save Alibaba (NYSE:BABA) and its falling stock. The sentiment remains extremely negative, economic data from China don’t spark optimism either, and investors deploy their funds into large-cap American tech stocks since they have produced the best returns again. Chinese companies remain “uninvestable” according to many, as the environment around them is considered to be risky.

There have been dozens of articles on Alibaba and how cheap it is. There also have been hundreds of arguments as to why the market has been wrong. All the valuation methods show that the Chinese E-commerce giant is a screaming buy and that the acquisition of its stock is an opportunity of a lifetime. Yet, the price keeps falling.

I belong to the group of Alibaba investors whose bullish sentiment remains strong. I wrote several articles on the company over the years, where I kept coming up with more and more arguments for why the business was a buy, the more it fell. By looking at the stock price today, and points in time when I rated the business a Strong Buy, it’s fair to say that it’s been a terrible investment. Indeed, it has been so far. On the other hand, an investor doesn’t lose money on an asset until he sells it at a loss.

For value investors who often hold a business for a long term, it’s important to revisit the investment thesis once in a while.

• Were my assumptions correct?
• Did the fundamentals change dramatically?
• Are the risks greater than before?

These and other questions focused on the business fundamentals should be answered. Previous articles give me an excellent opportunity to look back, reflect, and reconsider the investment thesis

E-Commerce Giant In The Midst Of A Hurricane

On November 19th, 2020 I wrote an article Alibaba: E-Commerce Giant In The Midst Of A Hurricane. The company was just hammered with the Ant Group IPO suspension. The sentiment began to drop. In the article, one can read:

A few days before the initial public listing the company would have raised just under $34.5 billion – setting a new world record and valued it at $313 billion.

Unexpectedly, two days before the public offering the news broke out with doomsday headlines that the transaction would get postponed due to the regulatory situation. An important word for the sake of this article is “postponed.”

The market has been right about Ant Group. The company isn’t publicly traded after three years. The valuation of the financial firm is currently at $78.5 billion. This valuation represents a substantial decline of approximately 75%, equivalent to $230 billion, compared to its valuation nearly three years ago when Chinese regulators canceled its initial public offering (IPO).

Another matter discussed in the article was Alibaba’s quarterly financial performance.

The management sounded very optimistic about the long-term outlook for Alibaba in general, as well as for the single businesses it owns. One of the main drivers of tremendous results Alibaba delivered was the condition of the Chinese robust economy which has been recovering in a fast pace from the pandemic.

The management has sounded optimistic ever since. In the earnings call for the September 2023 quarter, the overall tone was upbeat as always, showcasing Alibaba’s positive results, strategic direction, and commitment to long-term value creation for shareholders. However, the fast pace recovery from the pandemic didn’t happen. China imposed tough policies, that significantly slowed down the return to normality.

The last point of focus in the piece was a regulation restricting anti-competitive practices.

Unquestionably, Alibaba has created a tremendous value through its various brands and stickiness of their platforms that attract millions of customers. The implementation of the anti-competitive rules will probably not change it in any meaningful way or negatively influence a company’s position in the market.

Unfortunately for Alibaba, in the last 3 years, the Chinese government has introduced several regulations to fight anti-competitive practices and promote fair competition in the country’s economy. These regulations have had a significant impact on the behavior of large tech companies in China. For example, Alibaba has been forced to change its algorithm for ranking search results, and Tencent (OTCPK:TCEHY) has been prohibited from requiring developers to use its proprietary payment system.

The Chinese government’s crackdown on anti-competitive practices is likely to continue in the years to come. As the country’s economy becomes more reliant on technology, the government is likely to become increasingly concerned about the potential for monopolies and market abuse.

In the article, I called Alibaba a solid business with massive potential far in the future. The events from late 2020 set the tone for investors for the years to come and this negative sentiment persists, although the Ant Group IPO or the anti-competitive practices are not discussed anymore. Nevertheless, Alibaba remains a solid business. The potential is also massive concerning the artificial intelligence field, an opportunity in the chip design space, content strategies, the potential for partnerships, and the evolving landscape in streaming and linear TV. Although the landscape has changed, it leaves a lot of room for innovation, development, and growth.

Common Sense Investing In Alibaba

On October 11th, 2021, almost a year later, I wrote another article titled Common Sense Investing In Alibaba. The focus of this piece was laid on three main matters: business fundamentals, a big perspective, and cloning.

Fundamentals

Those days Alibaba was delivering growing sales way faster than now with revenues up 34% YoY and non-GAAP net income in the first quarter of the FY 2022 of RMB 43,441 million ($6,728 million), an increase of 10% YoY. Recently, Alibaba reported an 11% revenue growth YoY and a 21% increase in non-GAAP net income. Although sales numbers significantly slowed down, the company’s free cash flow more than doubled from RMB 20,683 million to RMB 45,220 million.

In terms of margins, Alibaba experienced a dent. However, the operating margin just reached a two-year high, and the net margin sharply rebounded.

The gross margin suffered the most, but a stabilization can be observed.

Another positive sign is an improvement of other important profitability metrics such as Return on Invested Capital (ROIC), Return on Assets, and Return on Equity. Charlie Munger, the legendary investor and vice chairman of Berkshire Hathaway (BRK.B), placed significant importance on the ROIC as a key metric for assessing the long-term value of a business.

• ROIC measures how efficiently a company generates profits from its invested capital. A high ROIC indicates that a company is using its resources wisely to create value.

• Over the long term, stock performance tends to mirror the underlying business’s profitability. A company with a consistently high ROIC is more likely to generate sustainable earnings growth and deliver superior returns to its shareholders.

Trudy Dai, the CEO of Taobao Tmall Group referred to the current ROIC:

… we are looking very closely into our ROIC. And we do set a target that we want to increase the ROIC to double digit in the next few years. There is a few ways we will take to achieve that target. In all our businesses, if you like, actually, as Eddie mentioned, we do have core and non-core business.

Alibaba shows strong fundamentals. The company has a dominant market position, stable revenue growth, high profitability, a strong balance sheet, experienced management, and long-term growth potential.

Big Perspective

A big perspective considering the Chinese economy, the fierce race for world dominance, the China 2025 initiative, or a high-growth environment, hasn’t changed. Although the Chinese government acts differently than investors might wish or would expect from Western countries, common sense suggests supporting the country’s biggest companies employing hundreds of thousands of workers, as I indicated:

The solutions provided by Alibaba are highly innovative and can’t be easily replicated by its competitors. Shouldn’t the government support or at least not interrupt? In the end, it’s about reaching the economic goals in, or even better, ahead of schedule.

The Chinese government has taken several steps to support innovation and domestic growth. These include:

• Investing in research and development ((R&D)): The Chinese government has increased its spending on R&D in recent years, and it now ranks second in the world in terms of total R&D spending. This investment has helped to support the development of new technologies and industries in China.

• Creating special economic zones ((SEZs)): SEZs are designated areas where businesses are allowed to operate under more flexible regulations. This has helped to attract foreign investment and to create a more favorable environment for innovation in China.

• Supporting technology startups: The Chinese government has launched many initiatives to support technology startups, such as providing funding, incubators, and tax breaks. This has helped to create a vibrant startup ecosystem in China.

• Promoting domestic consumption: The Chinese government has implemented several policies to encourage domestic consumption, such as tax breaks for homebuyers and subsidies for consumer electronics. This has helped to boost the domestic economy and create demand for goods and services produced by Chinese businesses.

Cloning

The idea of cloning in the investment world was popularized by a famous value investor, Mohnish Pabrai, who has always been open about the idea of copying others’ asset purchases. In late October 2021, Alibaba’s stock price was around $170 a share, and some of the respected investors, such as Charlie Munger, Guy Spier, and Mohnish Pabrai were either initiating positions in Alibaba or were already invested in the company. I finished the article with these two short paragraphs:

Can these two gentlemen, Charlie Munger and Mohnish Pabrai, who place bets so rarely, and when they do, they do it with such a high conviction, be wrong on Alibaba?

Of course, they can. However, the odds of being wrong on Alibaba after considering its valuation, big perspective, and implementing the idea of cloning are very small. On the other hand, the upside potential is substantial at this moment. This can be an investment opportunity of a lifetime.

Luckily, I wrote that they could be wrong. Charlie Munger, who recently passed away at the age of 99, revealed in his last interview, that Alibaba was his worst investment.

Well, my worst trade was buying a block for the Munger family in Alibaba, which is a pretty good company. But I think it got over-hyped. And Jack Ma was – made mistakes in dealing with the Chinese government.

– Charlie Munger for CNBC

Having Charlie Munger as an investing role model, and being an Alibaba investor at the same time, made me feel a bit disappointed, although I owned Alibaba shares a long time before Charlie Munger started his position in 2021. Besides that, Mohnish Pabrei quickly sold his shares as a part of a tax harvesting strategy. He purchased Tencent instead, whose stock price has also gotten wrecked. After all, cloning doesn’t seem to be such a great idea in investing as well as in life. Those who followed these two respected investors probably lost their conviction over time and sold their shares as well.

Valuation

To get an idea of how much Alibaba is currently worth, a discounted earnings model was applied with the following input data:

1. Alibaba’s earnings per share will grow 17.5% with a compound annual growth rate (CAGR) over the next five years, according to Seeking Alpha.
2. Growth will slow down in the following five years and settle at 8.7% CAGR.
3. Perpetual growth after ten years will equal 2.0%
4. The discount rate is 10.0%.
5. A margin of safety is applied and equals 15.0%.

Without a deeper dive into growth numbers, margins, etc., Alibaba looks undervalued by 30.0%. The valuation doesn’t matter, as long as the sentiment around China and Alibaba is so low. No positive news seems to help the company. Even announcing a dividend, as well as the continuation of the large share repurchase program did not affect the stock price. All that mattered at the last earnings call, was the suspension of the IPO of the cloud computing segment

Accordingly, in addition to our $40 billion share repurchase program, we are pleased to announce that our Board of Directors has approved an annual dividend for fiscal year 2023 in the amount of $0.125 per ordinary share or $1 per ADS. The aggregate amount of the dividend will be approximately $2.5 billion.

Risks

Besides the reward, that an investment in Alibaba offers, there are also risks. They are no greater than those associated with investing in large American tech companies. However, they are different and there are more uncertainties related to the company such as Alibaba. To be specific, the unknowns related to the foreign country, its regulations, and a very different way the government deals with certain make investors scared. Some of the main risks include:

• Regulatory scrutiny: The Chinese government has been cracking down on anti-competitive practices in recent years, and there is a risk that Alibaba could face further regulatory scrutiny. This could hurt the company’s growth and profitability. Tencent is the most recent example of an unexpected regulatory policy that spooked investors and tanked the stock price.

• Economic slowdown: The Chinese economy is expected to slow down in the coming years, and this could put a drag on Alibaba’s growth.

• Competition: Alibaba faces increasing competition from domestic and international rivals. This competition could put pressure on the company’s margins and profitability.

Investors should carefully consider these risks before investing in Alibaba. It’s been long three years since the destruction of the company’s stock price started. There might be a long recovery and a sluggish way up ahead or further struggle.

Conclusion

Reviewing these two articles which I wrote around three and two years respectively, gives a great overview of the arguments, reasoning, and perception of the situation those days. I could revisit the thesis and reflect on what has changed since then. There were assumptions I was completely wrong about. Some arguments are still valid. Some estimates didn’t materialize the way I expected, but the big picture remained the same.

Alibaba holds a strong market position, with solid financials that enable it to invest in growth opportunities and weather economic downturns. What I found always compelling about the E-commerce giant was its diversified business model. Alibaba is not just an e-commerce company. The company also has a strong cloud computing business, a thriving digital entertainment business, and a growing logistics business. This diversification helps to reduce the company’s reliance on any one sector and makes it more resilient to economic downturns. Besides that, Alibaba’s revenue growth is expected to accelerate in the coming years, driven by the increasing adoption of e-commerce in China, the growing affluence of the Chinese middle class, and Alibaba’s expansion into new markets. A cherry on top is the business forward earnings yield of 9.1% which constitutes a rare opportunity.

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