By Ee Hsin Kok. Edited by Swastik Patel.
Overview
Alibaba is the largest retail commerce business in the world by Gross Merchandise Value and is the third largest Chinese company, behind only Tencent and Moutai. Almost exactly one year ago, I wrote this article (read it to get a better understanding of Alibaba’s business model) on why Alibaba was a great business at a great price. At the time, Alibaba had a market cap of 570 Billion USD. Today, Alibaba is trading at a market cap of 280 Billion USD, less than half of its value a year ago.
An Even Better Deal Than Before
Over the last 12 months, Alibaba’s market cap has essentially halved. The stock’s price has dropped from the $200+ range to $102 today. In that same time period, Alibaba has grown its revenue from $717 Billion CNY to $853 Billion CNY (roughly equivalent to $148 Billion USD to $177 Billion USD) . It also surpassed its 1 billion active consumer milestone in China. This means in a challenging year for the company, plagued with government crackdowns, additional covid lockdowns in China, and tons of bad publicity, Alibaba still managed to grow its top line by nearly 19%. While the stock price halved, revenues increased by nearly 20%.
A Quick Updated Valuation
In Alibaba’s Fiscal Year ending March 31, 2022, the company generated $98.8 Billion CNY in free cash flow (FCF). If we add back the $18.2 Billion CNY used to cover the fines, we get an adjusted FCF value of $117 Billion CNY (around 17.31 Billion USD). The reason we adjust the FCF is because we are going to project future cash flows from this adjusted FCF. A one time fine that is fully paid off should not be a factor in Alibaba’s projected future free cash flows.
Alibaba has 2.7 Billion outstanding ADS shares, so that works out to about $6.40 of FCF per share. In this model, we will assume Alibaba grows its free cash flows at a 10% organic growth rate for the next 5 years (excludes buybacks), and then will follow it up with 7% growth from years 5 to 10. We will then discount all cash flows at a 10% discount rate, giving us the following cash flows:
From then on, we will need to calculate the terminal value. Assuming a perpetuity growth rate of 4.00% – which is very reasonable for a company like Alibaba in the fast growing economy of China – we get a terminal value of $234, discount that back to a present value, and we get $90.29. Add all the discounted cash flows to the terminal value, and we arrive at an intrinsic value of $151. Furthermore, Alibaba has net cash of about $17.5 per share, so we add that to the intrinsic value to get a final value of $168.5. Compare that to Alibaba’s current price of $102, and the company looks like a steal, with a 40% margin of safety.
Additionally, keep in mind that the growth rates we are using (10% followed by 7%) are extremely low, and that we are projecting off a very low base. Alibaba is coming off a down year in terms of FCF, and is expected by analysts to easily do more than $8 of FCF/s by 2023. In our model, the 2023 FCF is only $7.74, and we still come up with a valuation with a 40% margin of safety.
If we were to be even more bearish about the future of Alibaba, let’s assume the company only grows 7% for the next 5 years, 5% for years 5-10, and then has a perpetuity growth rate of 3%. This bearish scenario produces the following model:
Which shows that the intrinsic value of BABA for a 10% return, is still around $138. Which gives a 27% margin of safety.
Finally, let’s be more bullish on the company. After all, this company has grown its revenue by 20% even in a down year, and this bad year of Free Cash Flows is simply just that – a bad year. If we believe that Alibaba’s growth will return, that their free cash flow margins can expand back to their old levels of around 15% (they are at all time lows of 12% now), then we’ll project FCF per share levels of $8.5 for 2023 (in line with analysts estimates), then growth of 12.5% for the first 5 years, 10% for years 5-10, and then set a perpetuity growth rate of 4.5%. This is a highly likely scenario, and it produces the following model:
The model shows that the intrinsic value of BABA for a 10% return, is around $220. Which gives you a 54% margin of safety.
Risk To Reward
Whenever you enter a position, you want to consider the risk to reward ratio. With a stock like Alibaba, there are big risks due to the nature of the political system in China. The Chinese government is extremely powerful, and isn’t exactly known for being the most transparent. However, the government has come out and said it wants to support its businesses, and from a logical point of view, it doesn’t make a lot of sense for the Chinese Communist Party (CCP) to destroy China’s number one e-commerce business. Alibaba recently crossed the 1 Billion annual active user mark this year, which just goes to show how essential the company is to the economy of China. Does it make sense that it would be in the CCP’s best interest to destroy Alibaba? Especially in the midst of an economic war with western countries.
Now let’s consider the reward. Here we have a company that is essential to the economy of China, the fastest growing middle class in the world, and will soon be the top economic power in the world. It has plenty of catalysts for future growth (secular growth for the cloud, e-commerce, China’s economy), it’s trading at a very low valuation, has tons of cash relative to debt, and you can buy it with a tremendous margin of safety. Never invest what you’re not prepared to lose, this is not advice to put your entire life savings into Alibaba. However, from a risk-reward perspective, Alibaba seemed like a good bet last year, and an ever greater bet right now.
