Alibaba Fell More Than It Seems

Summary

  • Alibaba sure fell a lot already.
  • Yet, if one looks closer, one will notice that it actually even fell more than is apparent.
  • This means that Alibaba actually looks significantly cheaper than what one would gather just from Price/Earnings measures.

Looking at Alibaba, one can already perceive a massive drop in the share price. From a high over $305 barely 1 year ago, the stock is today down all the way to $110. That’s a 64% drop right there.

However, in fact Alibaba fell even more than is readily apparent, and thus is now too cheap to ignore even considering the risk that the U.S. might be politically motivated to delist Alibaba along with all other Chinese stocks.

Why do I say this? For a simple reason: Alibaba has negative leverage. That is, it has a number of assets which aren’t really part of its main business which together hold significant value, including:

  • A 33% shareholding on ANT Group (worth $30 billion based on a $90 billion overall valuation)
  • $61.6 billion in net cash
  • $38.3 billion invested in equities

To see how much Alibaba’s business is worth, or said another way, to calculate its EV (Enterprise Value), one needs to exclude these assets.

Since, put simply, EV = Market capitalization + net cash – extra-operating assets, this means that Alibaba’s EV is lower than the market capitalization. In fact, net cash plus these extra-operating assets now amounts to $129.6 billion.

Hence, Alibaba’s EV is much lower than it seems. Now notice the following, since EV is lower than market capitalization, any given drop on market capitalization will produce a more-than-proportional drop on EV. What this means, is that Alibaba gets cheaper quicker than it drops.

For instance, in a simplified manner, let’s suppose that when Alibaba was at $305, this value which needs to be excluded was already $129.6 billion. Here’s what the actual drop in EV would have looked:

  • At $305, EV would have been $835 billion in market cap minus $130 billion in these assets, so $705 billion.
  • At $110, EV is $301 billion in market cap minus $130 billion in these assets, so $171 billion.

And there you have it, the value of Alibaba’s business dropped not 64%, but a massive 75.6%.

Now, the difference between a 64% drop and a 75.6% drop might not seem much. But consider the following: after a stock drops 64%, it has to drop another 32% to get to a 75.6% drop on the original price.

This Has A Large Impact On Valuation

Most serious valuations based on multiples will be based on EV, not Price. After all, we always need to consider both how much net debt a company might have, or net cash, in this case.

If not, it could happen that a profitable company had more cash than market cap and still, because of rather low interest rates and earnings, show up with a Price/Earnings which didn’t look cheap. This in spite of such company literally being free if it was possible for an acquirer to buy it all at market prices.

Hence, an EV/Sales or EV/EBITDA multiple will tell us more about a company’s valuation, than a mere Price/Sales or Price/Earnings.

It so happens that, as I said earlier, EV fell faster than market capitalization. Hence, EV/Sales and EV/EBITDA fell faster than Price/Sales or Price/Earnings.

Of course, BABA has fallen so much that it now even looks cheap on a Price/Earnings. For instance, BABA now trades for just 13x the FY2022 EPS consensus. That already looks cheap, but you can still find many unloved companies at 13x earnings or lower. For instance, in the pharma sector (usually when they’re facing threats in the near future).

However, on an EV/EBITDA basis, the multiple looks even cheaper because of those assets which need to be excluded from EV. On that measure, BABA now trades at around 7.1x EV/EBITDA. That’s lower than the pharma companies go. And indeed, lower than nearly anything else in the US market that’s not immediately challenged. And especially, it’s much lower than any equivalent high-growth, high-margin, high-quality companies in the US market. The US market in general goes for around 18x EV/EBITDA. And high-quality companies go for much more than that, for instance:

  • Apple – 22x forward EV/EBITDA
  • Microsoft – 25x forward EV/EBITDA
  • Amazon.com – 26x forward EV/EBITDA
  • Google – 17x forward EV/EBITDA

Other Considerations

There’s little doubt Alibaba is a high-quality company. It dominates China’s eCommerce market, based on a 3P marketplace concept (which typically ensures high margins). It also dominates China’s IaaS cloud market. These are highly desirable sectors outside of China, which typically command premiums to the market. Alibaba also has many other exposures and growth initiatives on top of those two cores.

At the same time, Alibaba’s profitability is actually depressed by significant growth investments. For instance, Alibaba’s latest quarter shows how these investments impact reported EBITDA:

The A, B, C, D impacts are clear and rather easy to revert. The cloud computing segment is rapidly turning profitable, but still has a low positive impact. Yet, the cloud segment has the potential to actually contribute heavily to BABA’s profitability just like it does for Amazon.com.

The other impacts are more speculative as they represent investments in the future which might take a while to produce results.

My own EBITDA estimates consider only the A, B, C, D impacts to be reversible. Of note, Seeking Alpha’s EV/EBITDA valuation is somewhat broken since it fails to consider the large equity investments, as well as the entire ANT financial shareholding (33%). This is also common elsewhere: the market probably isn’t seeing just how cheap Alibaba got (though it is seeing that Alibaba got cheap).

Not everything is good, of course. For instance, BABA recently had a large growth guide-down for FY2023. However, BABA still guided for significant growth. And moreover, one should consider that the current high growth rates were greatly influenced by a retail segment getting consolidated from October 2020 onwards. BABA is lapping that event, hence lower growth was already baked into the cake. Here’s the relevant line:

The China Question

There’s no doubt that the Chinese regulatory environment turned less favorable recently. China is now trying to contribute more to “Common Prosperity”, and the reason is obvious. Inequality is nuts in China. Estimates put China’s GINI index as high as 46.8 (though declining):

Source: CEICdata.com

Even the United States, famous for the ongoing inequality griefing, sits at a much lower level (though stable to growing):

Source: CEICdata.com

Hence, some political and regulatory movements to reduce inequality somewhat are to be expected. These can hit individuals, but they also often hit corporations – namely measures to not let monopolies abuse their market power. But at least from reading Xi Jinping’s speeches, China isn’t about to quit on capitalism.

Hence, there’s not much reason to believe whatever changes result from China’s drive towards greater equality and less market power will end up producing a situation more unfavorable than that experienced by large megacap tech companies in the West.

Conclusion

For the purposes of this article, there are two main conclusions: Alibaba’s business value actually fell a lot more than it seems going from market price alone. And as a result, Alibaba stands cheaper (on Enterprise Value measures) than one would expect.

Given the valuations reached, the ongoing growth, and the high-quality, high-margin business Alibaba is, the most recent drop (today’s) finally turned me very bullish on the name.

Of course, a lot more could be said. For instance, right now China is still going through an economic slowdown. And above all, the United States can, at any moment, decide to delist Alibaba (and other Chinese companies’) shares from the US markets. That would surely produce a further sharp – but temporary – drop in share prices.

Still, even if delisting happens the stock would continue to list in Hong Kong and the shares would simply be exchanged for HK shares. Or an investor could sell in the United States and buy simultaneously in Hong Kong. Alibaba’s business wouldn’t be affected, and at the present valuation, any drop would be temporary.

Finally, the news creating the very latest drop, on delisting this and that, were prompted by DIDI wanting to delist itself from the US under pressure from Chinese authorities. But Chinese authorities only turned on DIDI because it didn’t respect these authorities’ position that DIDI should have delayed its IPO. There is no ongoing, wide, movement from China to have Chinese companies be delisted from US markets. When it comes to Alibaba, any and all delisting risk comes from the American side, not the Chinese. Hence, it doesn’t make a lot of sense to react to DIDI doing this or that.

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