I think in the universe of publicly traded Chinese tech companies, few could match the astounding growth of Alibaba.
Indeed, many investors have included Alibaba in their stock portfolio, either directly through the purchase of its shares in the US or Hong Kong stock exchange, or indirectly via a passive ETF (BABA is within the Hang Seng TECH Index, Vanguard FTSE Emerging Markets ETF (VWO) and Ark Fintech Innovation ETF (NYSE: ARKF)).
I do not currently own shares of Alibaba, however, if you are a long term buy and hold passive investor like me, Alibaba will probably be in your watchlist.
Its massive scale and growth is truly impressive (see below – from its 2020 Annual Report).
The recent drop in the share prices came as no surprise given the headline news (which has been flashing in Channel News Asia and in the front page of the business section of The Straits Times, and many other major news outlets). Simply said, one just can’t miss it.
China launches probe into Alibaba for suspected monopolistic behaviour (read here)
1) Valuation Metrics compared to other mega tech stocks
In addition, as mentioned earlier, when it comes to quality mega tech growth stocks, Alibaba is in a class of its own. China is a very different country in many respects. One of these things is the nationwide restriction on internet access in the country, as you may have heard of it before, a lot of the most used websites are inaccessible from within China, including Google and Facebook. So in China, the 3 big tech companies, Tencent, Alibaba and Baidu can still operate without much competiton from some of the global/US mega tech companies.
Many things are relative.. it is how we perceive them. When it comes to investing, to many, some things are considered expensive or cheap only when we compare them with their peers.
To quote Rolf Suey in his 24 Dec 2020 post: “Alibaba has FCF of USD24B over revenue of USD90B (27%), comparable to Apple as being a cash cow. In comparison, Amazon has a FCF of USD27B over revenue of USD322B (8.4%), that pales Alibaba. Despite the profitability, Alibaba’s PE (ttm) is a mere 25 (today’s HKSE price) that is way cheaper than Apple’s 40 and Amazon’s 93.”
So indeed, if I liked Alibaba stocks (HKG: 9988) when it was at HKD 307.4 a share on 28 Oct 2020, I would like it more now (on 26 Dec 2020) at HKD 228.20 a share. The current P/E is 27.54 (from Poems).
“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” Warren Buffett
Indeed when compared to the other mega tech stocks, Alibaba’s current valuation metrics appear cheap. See below.
However, its market cap / revenue ratio is not the lowest (Amazon, Alphabet and Baidu’s ratios are lower).
2) The Ant Group factor
Start by asking: How bad can things become?
The other big news prior to the authority’s probe into Alibaba for suspected monopolistic behaviour would be the suspension of the Ant Group IPO in Nov 2020.
So much has been written about the much anticipated listing of Ant Group on the Hong Kong Stock Exchange (HKEX) and Shanghai’s STAR market (officially known as the Shanghai Stock Exchange Science and Technology Innovation Board) in early November. The dual listing which was expected to raise an estimated US$34.5 billion would have been the biggest IPO in history.
With Ant Group’s record $34.5 billion IPO suspended, what happens next? (read here)
Now IPO valuation aside, we are aware that Alibaba owns 1/3 of Ant Group and in its 2020 Annual Report, it states that this stake is worth approximately RMB 71.6 billion or HKD 84.87 billion (after factoring the cost reimbursement and deferred tax effect) – see below.
Now the Common Shares Outstanding of Alibaba (9988.HK) is 21.492 billion. Given that on 28 Oct 2020, its share price was hovering around HKD 307.4, that would give it a market capitalisation of HKD 6,608 billion at that time. Bear in mind that the market capitalisation of Alibaba today (26 Dec 2020) is HKD 5,373 billion, a 18.7% drop.
Now assuming the worst case scenario (which I seriously doubt it would happen), for instance that the Chinese authorities went hard ball, and basically Ant Group is obliterated (from China), or it became a state own entity, resulting in the total crash of Ant Group’s value and hence Alibaba’s 1/3 stake in it is gone (which is supposedly worth HKD 84.87 billion not too long ago even without the IPO listing).
In other words, a complete write off of Ant Group from Alibaba’s balance sheet, so to speak.
That would mean that Alibaba’s market capitalisation would have technically dropped from HKD 6,608 to HKD 6,523 billion.
3) The Fine Factor
Regulators had previously warned e-commerce giant Alibaba about the so-called “choosing one from two” practice under which merchants are required to sign exclusive cooperation pacts preventing them from offering products on rival platforms.
The State Administration for Market Regulation (SAMR) said in an online statement that it had launched a probe into the practice.
Ant said it had received a notice from regulators and would “comply with all regulatory requirements”.
Now in the below article, to quote: “Cui said the consequence of the investigation this time could be more severe than the 500,000 yuan Alibaba was fined this month. Chinese lawmakers are revising antimonopoly laws, which could mean the maximum fine is lifted to 10% of a company’s annual revenues.“
Jack Ma’s Alibaba and Ant targeted by China regulators (read here)
So it states that the maximum possible fine that the authorities could impose on Alibaba is 10% of its revenue. Well, we all know that given the size of Alibaba and it is basically an ‘eco-system’ with many parts, so the fines may not be on the whole of Alibaba, but maybe some of its divisions.
To quote its 2020 Annual Report: “Our businesses are comprised of core commerce,
cloud computing, digital media and entertainment, and innovation initiatives. In addition, Ant Group, an unconsolidated related party, provides payment services and offers financial services for consumers and merchants on our platforms. A digital economy has developed around our platforms and businesses that consists of consumers, merchants, brands, retailers, third-party service providers, strategic
alliance partners and other businesses.”
However, for simplicity sake, let’s again assume the worst, and the maximum penalty of 10% is imposed on Alibaba’s total revenue which was RMB 509.7 billion or HKD 605.60 billion in FY 2020. That would be a fine of approx. HKD 60.56 billion. The revenue figure would probably be higher in FY 2021.
Hypothetically that is an outflow of approx. HKD 60.56 billion from the annual net profit just to pay the fine. However, we did not consider the financial impact to the underlying business though (to comply with the rules).
Taking into consideration that in Dec 2020 (this month) the market regulator only fined Alibaba and Tencent Holdings 500,000 yuan (HKD 592,654) each for failing to seek regulatory approval for past acquisitions. So HKD 60.56 billion is a crazy huge amount.
So factoring the above mentioned obliteration of Ant Group value and the max. 10% fine (of the revenue) imposed, the market capitalisation would have further dropped from HKD 6,608 to approximately HKD 6,462 billion.
The market capitalisation of Alibaba today (on 26 Dec 2020) is HKD 5,373 billion. So this figure is still lower than the calculated figure considering the above mentioned worst case scenarios.
However, I may have missed out some other factors, considering the negative impact of the new regulations on Alibaba existing e-commerce and fintech businesses.
4) Be patient. It could get worse.
Everyone’s circumstance is different. For me, my focus now is on building a war-chest, although that does not mean that I would ignore any opportunity that comes my way. I am always looking for situations whereby there is a very distinct divergence between the value and price while understanding the factors causing it. When it comes to good companies, the lower the price the better.
We like to think of ourselves as ‘contrarian’ investors. However, when shits really happen … not many will execute.
By the way, a good book which I have just read, which I think is full of short paragraphs and sentences with deeper meanings, for thinking about investing is “The Sceptical Investor: How contrarians bet against the market and win – and you can too” by John Stepek
When it come to China related stocks, which I am not really familiar with in terms of regulatory requirements (kind of opaque in my opinion), I would probably demand a higher level in terms of margin of safety. Would we have a public hearing like what we had for the mega tech firms in the US, I doubt so.
Bearing in mind, while we are thinking of buying shares of this companies, existing Alibaba shareholders are mulling the red on their screens as well (and probably thinking of the way forward to minimise losses – either average down, sell or hold).
I would give it time. I am probably wrong, and may miss the boat again.. but that’s life I guess. One way is to spread out my purchases over a period of time (if I like the price).
Alibaba stocks has been trending down since late Oct 2020 and we are now coming to the end of Dec 2020 (close to 2 months), and the normally outspoken Jack Ma has kept a low profile since then (probably on the advice of the Chinese authorities). There are many things we are not aware yet, other than the probe and the failed Ant group IPO, etc. It is just a black hole to me when it is related to the Chinese authorities… not much can be read from it.
When one finds a cockroach in his/her house, there is typically more than 1 cockroach in that house…The investigation only happened recently. Could be it by coincidence, that right after the failed Ant Group IPO listing, there are news of a probe into Alibaba…? Your guess is as good as mine.
We can never guess what the future will be, but we can probably guess what is the worst case scenario. Frankly, we should not wait for everything to be set in stone and good news being crystallised (when news start turning better) before investing.
Put it in another way. People always over-react to news. However, I do not know if we will have more bad news in the future. Why not? Still I can think and stress test the possible worst case outcomes via financial metrics. After all, Alibaba is cash rich and is not loss making… yet. It’s current ratio is only 1.99 as of 26 Dec 2020. Eg. The business has 2 times more current assets than liabilities to covers its debts.
As of September 30, 2020, Cash and cash equivalents were RMB301,509 million. Total current assets were RMB522,935 million. Total assets were RMB1,433,626 million.
Total Current liabilities were only RMB262,942 million and Total liabilities were RMB452,403 million.
Nevertheless, I do want to give this counter a few more months… (and also since I want to build up my war-chest; I have other priorities). I feel that I need to read more to understand. However, that is just me, and I can spread out my purchases. I feel that the markets can stay irrational longer than I can imagine. This stated period (of few months) is also dependent on any developing news. Currently there is a lot of speculation with no real hefty prosecutions, fines, sacking or detention etc…a 500k yuan fine mentioned earlier is really peanuts to a firm of this scale (Alibaba). More like just a slap on the wrist.
In the history of Alibaba, top executives have volutarily resigned or were sacked immediately due to wrong doings… it had happened. It can happen again.
Just think about it, in a short period of less than 2 months, more than a quarter of the share price of Alibaba (HKG: 9988) is wiped off due to some news….let this sink in for a while before you do anything. Imagine that happened to the value of your property… volatile stocks indeed.
On a side note, given the current valuation of Alibaba and the extend of its business in China, some might say, in the context of China, it might be ‘too big to fail’ – the fall of Alibaba would cause much disruption to other related companies in China and in other parts of the world.
Just bear in mind that Alibaba just had the best 11.11 performance which was quickly dashed after Beijing released draft rules. For many tech stocks, 2020 has been a great year. So how would 2021 be? Your guess is as good as mine, but I feel that for many mega tech stocks, there should not be many surprises, it probably won’t be as good as 2020, but still it should not disappoint too much. Nevertheless, things changed quickly….as what we can see from Alibaba (and the share prices of JD.com, JD health, etc).
My above points 2 and 3 are reference to when Alibaba stock prices are high in late Oct 2020… so how would 2021 be if there were no bad news for these mega tech stocks? With pandemic easing…
Alibaba’s $56 billion Singles Day record overshadowed by 10% stock plunge as China proposes new regulation (read here)
Depends on how you see the markets, there are always pockets of opportunities, we just need to spend time to do some research before jumping in. If you do want to invest in Alibaba, at least spend some time reading its latest Annual Report and Interim Report.
Do let me know your views below in the comment section.
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