Alibaba: Munger's Wisdom On Crises And Opportunities

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Alibaba: Munger's Wisdom On Crises And Opportunities

Seeking Alpha2023-08-23

The careers of many high-profile investors such as Charles Munger (and his old friend Warren Buffett) are largely made by seeing an opportunity amid a crisis.Recent developments surrounding Alibaba, ...

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However, seeing the opportunity takes more than linear and first-order thinking, which only shows the crisis. The careers of many high-profile investors are largely defined by seeing an opportunity amid a crisis that no one sees. Today I will focus on Alibaba Group Holding Ltd (NYSE:BABA) and Charlie Munger for two main reasons. The first reason is more obvious. Munger, or his Daily Journey Corp, holds a sizable position in BABA. He started the position against prevailing sentiment and when the stock price was severely battered. As you can see from the chart below, Munger's portfolio currently has a total of 4 positions. And BABA is the third largest one, representing more than 15.2% of the overall portfolio.Source: DataRomaThe second reason is that I see other developments in China that could be the catalysts that BABA stock needs via second-order effects. As such, the gist of my thesis is to argue that BABA is another case of Munger’s wisdom of buying a good stock while it's still on the operating table. I see the main reason for BABA’s stock price and valuation to be so depressed is the fear of regulatory pressure. And next, I will detail why these developments could just be the catalysts to push BABA off the operation table.China’s crisis and BABA’s regulatory pressureBABA investors certainly know that it had been (together with other major tech names) under intense regulatory pressure over the past 1~2 years. But lately, I see the multi-year crackdown on tech firms from Chinese regulatory authorities to be coming to an end. Several developments are worth mentioning.Firstly, its affiliate Ant Group was fined a total of $984 million for regulatory violations recently. Looking beyond the monetary value (which is pretty minor the way I see it), I see the penalty signaling the end of the last chapter and the beginning of a more cooperative period for Ant and BABA.Secondly and ironically, I see other economic issues that China is facing now to be a catalyst for the above regulatory easing. The main issue is concentrated in its real estate sector. Readers might recall that its largest developer of real estate, Evergrande, started having trouble a while back. And more recently, it just filed for U.S. bankruptcy protection. To add to the concerns, another one of its largest developers, Country Garden Holdings, already reported missed payments on its debt obligations earlier this month. The real estate sector contributes more than a quarter of the overall economic activity in China. And the trouble from two of its leading developers suggests a structural issue in the sector.Shortly after this development, the Chinese central bank reduced its key interest rates with the goal to stimulate the economy and investment. As seen in the chart below, all key rates dropped substantially in the recent few months.Against this backdrop, I do not see a good reason for China’s regulatory authorities to keep the pressure on its tech sector, especially leaders like BABA. It would be directly against the country's goal to reignite economic growth and upgrade its economy from real estate and manufacturing to a technology-based economy.Source: worldgovernmentbonds.comBABA’s valuation: A coiled springDue to the regulatory pressure in the past 1~2 years, BABA’s valuation is now severely compressed. By horizontal comparison (see the first chart below), BABA’s P/E (9.9x on FY1 basis) is at a sizable discount from its peers like JD and PDD. By vertical comparison (see the second chart below), its valuation is near a record low. To wit, its P/CFO ratio currently hovers near 7.56x, compared to a three-year median of 12.8x, let alone the ~24x before the crackdown started.Source: Seeking AlphaSource: Seeking AlphaFor a business that has no immediate liquidity concerns, such single-digit multiples should be applied only to companies that are terminally stagnating. Yet, BABA has been reporting healthy or even robust growth, and consensus estimates are forecasting such growth to continue in the future. To wit, its Q1 earnings (released on Aug. 10) reported strong growth across the board. Earnings grew 48% YOY on a non-GAAP basis. Revenue grew 14% YOY, and EBITDA grew 32%. Looking ahead, the consensus estimate (see the next chart below) forecasts a CAGR of 7.4% for the next five years. And speaking of liquidity, the company has such a large cash position that its valuation metrics are even more compressed when cash (or leverage) is adjusted for. As seen in the second chart below, its EV/EBITDA is only about 7.0x. Even at an entry price in the range of $100~$115, the EV/EBITDA multiple would still be in the single-digit range of 7.8x to 8.9x.Source: Seeking AlphaSource: Author based on Seeking Alpha dataOther risks and final thoughtsBesides the factors mentioned above, there are a few other positive catalysts afoot too. The company’s efforts to revamp its organizational structure are progressing smoothly based on the update provided in its Q1 earnings report. I expect such efforts to bear fruit in the near future. By restructuring into six operating units (Cloud Intelligence, Taobao Tmall Commerce, Local Services, Cainiao Smart Logistics, Global Digital Commerce, and Digital Media and Entertainment), I expect enhanced operational efficiency and innovation. Also, the approval of the restructuring itself from government authorities is a sign of a more collaborative relationship. In terms of downside risks, geopolitical risks are a major one. BABA often finds itself in the crossfire amid the U.S.-China conflicts. Delisting fear surfaces from time to time and triggers large volatility in stock prices. In terms of competition, the rapid growth of the Chinese e-commerce market is a secular tailwind. But in the near term, it attracts plenty of new entrants both domestically and internationally to compete with BABA.To conclude, my bullish thesis here is built on a second-order interpretation of the recent development in China’s overall economy. These economic issues, which could seem to be either negative or irrelevant for BABA, could be the signs that BABA’s regulatory pressure is coming to an end. The company is still reporting excellent profitability and growth in its most recent Q1 earnings report. Yet its valuation multiple is so compressed and the gap between its fundamentals and multiples is simply too large to ignore. Once the fear of the multi-year crackdown is removed, I anticipate the gap to be closed quickly. As detailed in the second section above, China’s recent moves to address its real estate sector and upgrade its economy are very likely to be the trigger here in the way I see it.Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"hasMoreComments":false,"newsSizeData":{"likeSize":22,"commentSize":0,"repostSize":0,"favoriteSize":2,"likeStatus":false,"favoriteStatus":false}}