No. of Recommendations: 9
I read through the recent Alibaba financial reports…
I’m not sure if
A. I am being lazy and going along with the Western consensus that the Alibaba reports are just too difficult to comprehend, or
B. The financial statements are deliberately trying to deceive me.
C. The financial statements provide all the information I need to get a handle on how the business is performing.
I kind of gave up but my initial impressions are below. Correct me where I am clearly wrong.
The new CEO is one of the original people that was around when Jack Ma founded the company. He spent several years since then, working on investments and knows exactly what drives financial markets. Risk that he is a skilled financial engineer.
I’m pleased he knows what the business is about and has a credible plan to turn around both business performance and stock market rating. The plan is well known: decentralise and reawaken entrepreneurial culture; break up and part sell off areas other than the core online retail businesses; achieve a stock market re rating and some business growth.
Some of the non core retail businesses (although not currently loss making or not generating meaningful earnings for the group) have very interesting market positions and enormous potential. The combination of the access to data on essentially a billion Chinese along side AI plus a dominant cloud position in China looks valuable for example. The recent failed IPO of the cloud business was due to US preventing advanced chip exports to China. Knowing the Chinese, I wouldn’t be surprised if they found their own solution and quickly. The investment in Ant Financial also looks valuable long term.
My reading of the current plan is to focus investors on free cashflow and cash on the balance sheet. Highlight that the free cashflow multiple to enterprise value is unusually low and under values the group. Lay off staff and cut costs and investment driving the free cashflow number. Unclear if the lay offs were removing previous inefficiencies, or under investing to drive free cashflow in the short term, at the expense of long term competitive positions. Hopefully the former.
There are three important areas I would like to understand:
1. Share based compensation. The focus on free cashflow is standard practice among tech firms. Alphabet is just the same. But that doesn’t make it right. I read the note on share based compensation and was lost and switched off. I know SBC is a big clip that must be taken into account after free cashflow. It explains the huge difference in the PE ratio based on earnings (excluding gains/losses on investments) and the FCF multiple which appears ridiculously low. How do they calculate the P&L SBC expense and how does it develop over time? I don’t view SBC as some, one off bonus for management excellence. It is more likely, as Buffett explained years ago (when it didn’t even go through the P&L) a normal cost of doing business. Alibaba can’t recruit, retain and motivate employees without paying them with equity in the business. I respect the employees in any tech firm demanding market rate compensation. But I do object to Alibaba and the standard practice of issuing shares out of thin air and then buying them back in the market with shareholder’s CASH, which keeps the share count from increasing too much and then asking me to focus on free cashflow. As I say, it’s standard practice in most firms but it looks like a big material number at Alibaba that I don’t have a handle on. For now, I will assume Alibaba is really around 9 or 10 times enterprise value.
2. Loss of market share to competitors in the core online retail businesses. Free cash flow has not fallen off a cliff, as you might assume from reading western media reports. There have been changes in the market place in recent years with how consumers buy online. Competitors were quicker to capitalise than Alibaba. The evidence for this are the large revenue increases experienced by competitors, while Alibaba’s revenues have been flat. Suggesting the overall market for online commerce is growing rapidly. Has Alibaba suffered from being a big slow to move organisation, combined with regulatory interference causing all kinds of distractions? Or is the moat just not that good? Or is is reasonable to believe that with the (understandable) anti monopoly interventions now complete and a new CEO with an entrepreneurial plan, combined with an incredibly big balance sheet - that Alibaba will still be around 20 years from now fighting it out with competitors. It’s a really important question and will largely determine my return from here but I see no reason to believe they will not be successful.
3. If some of the non core businesses are spun off, will they be sold off at below true value? I would like equity in any spin offs and obviously no funny business. Wider distrust of what might happen. I have some recollection of shady deals with Ant Group.
My current impression is that Alibaba was in an incredible position a few years ago. The combination of the dominance in online retailing and the payments business was an unusually strong position to be in. That is gone now but we are still left with some incredibly strong and profitable businesses with great long term prospects. That is valuable and they are not ordinarily on sale in the stock market.
Price is cheap, particularly considering how earnings are depressed buy the next generation business offshoots. And if these assets turn out to be very valuable for current shareholders, we are getting them for free.
I wonder why Charlie Munger was happy to buy at more than twice the current multiple. He clearly saw an incredibly strong business. Maybe it’s no longer just as strong. The next two years of trading will help reveal the strength of the organisation.
I will continue to hold and am looking forward to understanding the organisation better. Will certainly be interesting to watch what happens.
