Alibaba – Only You Know What Should Be Done

Summary

  • Alibaba shares look to have 75% upside today.
  • But – Alibaba investors face remote risks of total loss of capital.
  • Deals like Alibaba are rare in the market; if investors can handle the downside, Alibaba looks like a wonderful investment.
  • Alibaba makes sense as a position in a well-diversified value or growth portfolio.
  • We don’t know what will happen in the short term, but the business has great fundamentals. That makes the long term seem pretty appealing.

There have been a lot of articles on here recently about Alibaba.

And there are people on both sides of the argument:

Bulls:

  • Look how cheap BABA is on my DCF analysis!
  • Growing business, ridiculously undervalued on fundamentals

Bears:

  • VIE structure
  • Chinese Communist Party
  • China is awful
  • Delisting concerns

Ultimately, every investment is just a bet. You make an investment because you anticipate that the reward outweighs the risks. We all have a bit of a different approach to investing, but at the end of the day, we’re all the same.

The only thing we really have to know is if Alibaba offers an attractive enough risk/reward to make for a good investment.

Valuation

3 weeks ago, I published my first article on Alibaba. The share price has fallen about 14% since then. From the quantitative side, BABA just got way cheaper and makes for a much better investment:

Source: Author

Today, BABA looks to offer 73% upside. Of course, this is just an estimation – I have no idea what price the stock will move to in the short term. But over the long term, BABA looks to have significant upside.

The stock market is a device for transferring money from the impatient to the patient.

– Warren Buffett

How likely is it that BABA is worth way less over the long term than fundamental estimates suggest?

BABA would only be worthless over the long term if the fundamental value significantly decreased:

  1. Lower revenue growth than predicted
  2. Lower profitability than predicted
  3. Something catastrophic happens to the business

Today, shareholders are most concerned that something catastrophic could happen to the business.

Could Alibaba be Killed?

Ultimately, the only risks that really matter for long-term investors like me and you are things that will hurt the business’s future profits.

Just for reference, here are the future profit estimations I used to calculate BABA’s present value:

Source: Author

Funds reducing their holdings of BABA may send a message that they don’t like BABA’s potential – but ultimately these moves have no effects on Alibaba’s future profits. So they don’t impact the business’s fundamental value.

What are some of the big risks that BABA faces?

  1. Delisting (low risk – investors would still own shares on OTC markets)
  2. VIE structure (medium risk – technically, shareholders could get left with nothing, but that would destroy BABA’s ability to raise capital in foreign markets)
  3. Chinese Communist Party Regulation
  4. Nationalization

I think investors for the remote possibility that BABA shares could one day be worthless for investors outside of China.

Legally speaking, VIEs grant no actual direct ownership of the underlying assets.

– Investment Ideas from UBS

Under the VIE structure, BABA shareholders outside of China don’t actually own shares. Shares could become worthless for investors, and it’s a risk you should consider.

But don’t forget that this risk has always existed. In October 2020, investors were paying over $300/share, and VIE risks were just as present then as they are now.

The lack of ownership may deter shareholders from wanting to invest in a very undervalued business. And there’s a chance that BABA could violate both of Buffett’s first 2 rules of investing:

Rule Number One: Never Lose Money. Rule Number Two: Never Forget Rule Number One.

– Warren Buffett

China’s on Sale

Nobody knows exactly what will happen to Alibaba.

But the times of greatest uncertainty can be the times of best opportunity:

The Volatility Index measures investor sentiment. When there was the most fear in the market in March 2020, that was a wonderful time to be investing.

Not every situation is the same, but it’s still interesting to keep this in mind, especially when negative headlines come out in the news.

Remember that Mohnish Pabrai, Charlie Munger, and Ray Dalio all own positions in Alibaba.

Recap

Chinese companies have risks because of the CCP. But with Alibaba fundamentally undervalued, and the world moving towards a global economy – I think BABA offers an attractive risk/reward.

I apologize for the brevity of this article. I’ve edited out pages of writing to give you the best content.

I cut out many pages of writing because those pages were attempting to predict the unpredictable. I don’t know what will happen with the Chinese Communist Party tomorrow.

All I know is that Alibaba is a pretty incredible company, offered at a pretty incredible price today. There are large risks with this investment, with the potential for total loss of capital.

I find it insightful to listen to Buffett in times like these:

Don’t watch the market closely.

– Warren Buffett

At the end of the day, we have a good business, trading at a very good price. BABA looks to have about 75% upside at current prices, and the company is growing at an incredible rate.

Despite considerable risks, Alibaba would make sense as a position in a well-diversified value portfolio because it’s very undervalued.

But only you can decide if you have the appetite for the potential risk. Analysts can publish article after article, bullish or bearish, but ultimately, that doesn’t matter. It’s up to you if you’d like to take this bet.

Thank you for reading. I wish you all the best.

Author: Thomas Richmond, Seeking Alpha

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