Revisiting My Alibaba Investment Thesis: Long Term Compounding Machine.
Introduction
Alibaba and other Chinese tech stocks have become one of the most divisive topics in finance of 2021. The CCP over the past year alone has increased regulations across the entire tech sector, pulled Jack Ma’s Ant Financial IPO, nationalized the online tutoring industry, and is currently taking aggressive steps to obtain what Chinese President Xi Jinping calls “common prosperity”. These events have managed to wipeout over a trillion dollars of market capitalization across the largest Chinese tech stocks. Alibaba’s stock price is currently down 26% YTD and is trading at a PE multiple of 20. The article I have written today is about why I believe Alibaba is currently priced at a bargain and why I continue to personally buy these dips.
Alibaba: The Pinnacle of Resilience
One of the larger catalyst for Alibaba’s stock price decline was China’s new anti-trust and anti-monopoly probes in which new regulations were placed to prohibit tech conglomerates from taking on business practices in which would be deemed “unfair” for smaller competitors. The regulators took these new rules so serious that they even fined Alibaba 2.8B USD as a result for an anti-trust investigation. Now at first glance this may sound bad, but there may be a silver lining in all of this. When looking at the long-term scope of Alibaba’s strategic initiatives and China’s tech sector, Alibaba can benefit from these smaller firms prospering. Alibaba is more than just an online marketplace, they have a diverse ecosystem of technology offerings which consist of cloud computing services, innovation initiatives and FinTech. The new increase in competition allows Alibaba’s other business segments to offer other services to new startups and provides them with more platforms to reach new consumers. E-commerce growth had to slow down at some point, so the CCP’s new push for fair competition in the tech space actually gives Alibaba an opportunity to expand its other business segments. Alibaba is already beginning to prove their resilience with their impressive 50% yoy revenue growth in its cloud computing segment. If these segments can continue to pick up the slack for the e-commerce growth slowdown, Alibaba’s future growth prospects remain optimistic.
Favourable Valuation: DCF Model
In this calculation, I use YTD FCF of 26.640 billion, a discount rate of 8% and a growth rate of 8%. I know that Alibaba has grown much more than 8% per year, however I like my DCF models to be calculated with a modest growth rate and to be as intellectually honest and reasonable as possible.
As you can see, I have an intrinsic value of $262.99 per share representing an approximate 55% margin of safety. My takeaway is that the headlines of the CCP’s recent muscle flexing has caused the shares of Alibaba to trade at a pretty heavy discount.
EPS Growth Rate Model
The next financial model is one favoured by Warren Buffet and the model basically consist of taking the current EPS and multiplying it by a growth rate for a number of years, than multiplying it by the average PE to predict the stock price and CAGR over the next few years. Keep in mind, this model assumes that NI margins don’t change much over the next 5 years.
The average PE of Alibaba was 39 and I am using 3 growth rates of 8,10 and 12 percent. In a best case scenario, if you buy Alibaba today you would get a CAGR of 35% over the next 5 years according to my model. This does not include Alibaba’s share buyback program. I think these yearly returns are very possible considering once the pessimism has subsided with this company, I expect Alibaba’s PE to reflect closer to its historical mean. These returns far exceed my desired 15% annual return, which leaves me with a healthy margin for error of my calculations.
A Note on VIE’s and Common Prosperity.
A lot of investors have been concerned about VIE’s (Variable Interest Entities) and the CCP potentially banning that work around for tech stocks to raise capital. As unpredictable as the CCP is, I do not believe that they will resort to such extreme measures such as patching up the loop hole or even delisting Chinese stocks off of American exchanges. I find that if China were to have resorted to actions like these, they would have done so long ago and I think the CCP is merely flexing its muscle at the moment. In regards to the recent initiatives of the CCP’s common prosperity goal in which Alibaba is contributing 15B over 16 quarters for, I find it can actually help Alibaba’s business in the long term. China still has hundreds of millions of people in poverty and if the private sector can assist with helping the state pull these individuals out of poverty, Alibaba will have more people and businesses to spend money on their services. I think investors should consider this 15B initiative to fund Common Prosperity as an investment and not a donation. Lastly, I do not think that common prosperity is a hidden sign that China will go back to more communist economic regimes as a matter of fact, it’s actually not much different than wealth redistribution programs in the western world.
Conclusion
I find that Alibaba’s recent headwinds are ultimately benign and that the impressive returns we once saw from the companies stock will return. As Warren Buffet says, “be greedy when others are fearful”, which seems to me like the perfect message for this stock. Just remember that a lot of these regulatory hurtles are necessary for a developing economy to transform into advanced developed nation and that the CCP is not going to dismantle what initially brought them their great economic transformation.