Alibaba: Q3 Was A Sign Of Things To Come
Wang He
I’m going to write this article a little differently than I usually do. For most of my articles I try to stick to a general outline: a brief introduction followed by the investment thesis into some information on thecompany, wrapping up with valuation, dividends and/or buybacks, and a conclusion. I try to keep articles under 1500 words because those are the articles I prefer as a reader. Today I’m going to ramble a bit and wrap up after talking some more about the valuation.
Painting a Hypothetical Picture
Imagine there is a stock with a market cap of $232B, which is down over 70% from its peak. There is political risk and the complexity of an ADR structure, but shares are dual listed on the Hong Kong exchange, and the ADRs can be exchanged for Hong Kong shares through your brokerage. While thecompany’s home country overreacted to the beer bug with harsh lockdowns, they have started to open up their economy in the last couple months. Their Q3 results were better than the first two quarters of the year, and I think we will see tailwinds in 2023 as their home country gets back to normal.
Approximately 90% of their revenue comes from China. While this creates uncertainty for American investors due to the so-called “China Discount”, I think that is why the valuation is so compelling today. Shares trade hands for just under $90 as I write this, which is up about 50% from the lows in October. The company has a cash rich balance sheet with $28.3B in cash and $45.8B in short term investments. They also have $33B in equity securities and $30.2B in equity method investments. This includes a 1/3 stake in Ant Group, which is one half of China’s fintech duopoly.
I’m curious to see what happens with Ant Group, which was pursuing a massive IPO a couple years ago. I don’t want to blow smoke, but I think the company’s stake is probably worth more than $30B. A quick peek at the liabilities side of the balance sheet shows approximately $23B in debt, which I don’t have any worries about given the amount of cash and equivalents on the balance sheet. The company has also taken advantage of the selloff to buy back a huge number of shares in the last couple years.
They repurchased 45.4M ADRs in Q3 for $3.3B, which is over 1% of the current market cap. The company earned $2.60 per share in Q3, a much better result than the first two quarters of the year. If you think like I do that this is sustainable, the company could earn $10 (or more) per share over the next 12 months. The buyback could also provide a nice tailwind for EPS and the current authorization has $21.3B remaining for the company to use over the next two years.
Another prominent investor has also recently taken a stake in the company. Michael Burry of Big Short fame recentlyboughtthe stock, which was approximately 10% of his portfolio at the time of the 13F filing at year end. Say what you want about the eccentric investor, but he has a history of identifying opportunities in the market with favorable risk/reward profiles. I don’t typically bury the lede like this, but that’s the position that Alibaba (NYSE:BABA) is in right now.
More on The Valuation
Alibaba stock is about as cheap as it has been since going public in the second half of 2014. Shares currently have earnings multiple of 11.5x, which is far too cheap even when you factor in the China discount if you ask me. If you factor in the company’s balance sheet, Alibaba looks even cheaper. If you just look at the cash and equivalents of $74.1B, the company has over 30% of its market cap in cash alone.
Price/Earnings(fastgraphs.com)
If you want to pull the $74.1B in cash out of the $232B market cap, that leaves us with a valuation of $158B on the rest of the company. That would put the P/E in the single digits, which I think gives long-term investors a lot of potential for multiple expansion in the next couple years. I don’t know if Alibaba will catch up to American tech companies as far as valuation, but I think today’s valuation is far too cheap. I don’t know what the short-term price action will be like, but I would be surprised if Alibaba is still trading below $100 in a year.
Conclusion
While I keep an eye on earnings when they come out for all the companies I own, sometimes I choose to wait a bit to write on a company to see how the market reacts and read some of the articles written by other authors. I thought there was a lot to like about the most recent quarterly report, and I think the risk/reward is very attractive for investors willing to stomach the volatility and risks that come with owning shares. If you told me that Alibaba would be down about 20% after the most recent earnings report, I would have been surprised to say the least. Chinese stocks aren’t for everyone, but I think the potential reward could be very lucrative for investors that understand the full picture with Alibaba.
Source: Seeking Alpha
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