In our previous coverage of Alibaba Group Holding Limited (NYSE:father), we noted that the stock was in value territory but unlikely to produce huge returns. This stemmed from prioritizing the macro over the micro and not considering the potential spin-off benefit.
We think that this “six degrees of separation” idea of separating all these units from BABA may reduce the regulatory risk, but will significantly increase the overall costs. It will also reduce pricing power further. We rate the stock as a hold and think those bulls should play it using covered calls.
Source: Six degrees of separation
This idea was strange, and it was interesting to see BABA fall sharply in its earnings release after announcing that it would no longer spin off Cloud Intelligence Group. Let’s see results, valuation and update why we believe investors can make some dough here.
A step back
Before we get to those results, it’s useful to see how much valuation compression or expansion can play a role in returns. Imagine the day of the US listing someone told you that BABA’s earnings will grow 1400% in a decade and they push you to bring your total earnings.
Most beginning investors would assume that you would likely see close to the same level of total returns. Smart investors like those who have lived through several bear markets and know what valuation metrics are important, if asked the same would be more conservative. They would point out the extremely expensive nature of the listing (24X price to sale) and perhaps go with a 200%-300% total return prospect.
But no one saw this.
This introductory price for multiple sales is really compressed.
This is one of the main (albeit less mentioned) reasons for diversification. Even when you get the underlying thesis perfectly correct, you can’t force the market to give it the correct multiple. So if you bet your retirement on a few stocks like these, well, you’re not going to back down.
BABA delivered a solid quarter compared to expectations and revenues expanded at a healthy 9% clip.
Operating income Non-GAAP income grew even faster at a rapid double-digit pace. BABA’s cost control was on full display here, and it remains the most profitable among Chinese online retailers.
The cash used for share buybacks was a bit small for most bulls and came in less than we saw last year.
The upside of this limitation is that at least BABA remains in a better position than companies like PayPal (PYPL) that blew the cash by buying back shares at multiples of the current price. The focus of the news was the cloud unit and its sales looked pretty weak.
But more importantly, BABA decided to cancel the IPO.
First, we announced in our earnings release that Alibaba will not pursue a full spin-off of Cloud Intelligence Group in light of the uncertainties created by recent US export restrictions on advanced computer chips. Instead, we will focus on developing a sustainable growth model based on the evolving AI-driven demand for networked and highly scalable cloud computing services.
Second, in August, Cainiao Smart Logistics filed its prospectus and application for an IPO on the Hong Kong Stock Exchange. While the success of an IPO transaction is subject to market conditions and relevant approvals, we are confident about the business fundamentals of our logistics unit.
Source: BABA Conference Call Transcript
Investors were hoping for a cloud listing to bail them out, and that won’t happen anytime soon. We want to point out here that the revenue growth of BABA’s cloud unit is extremely weak and we doubt it would be the game changer. However it is strange that the spin-off was discontinued for the reasons suggested. Management mentioned that the recent export ban in China led to the suspension of the cloud segment spin-off. Of course the US is hitting this harder and we just got news about Applied Materials, Inc.BIG) another day being in question. However, there has been some kind of export ban in place for quite some time. In fact, major developments took place more than a year ago.
So BABA knew this was on the table and had floated the IPO idea anyway. A more logical reason, and one that we think BABA didn’t include, was perhaps that the unit is unlikely to collect the kind of multiple the street expects. It will also require a very heavy cap to keep it competitive and they both argue for keeping it within the BABA group.
The biggest issue for BABA, and one we’ve looked at endlessly, continues to be the aftermath of the housing bubble.
While third-quarter gross domestic product figures released on Wednesday beat expectations for strong consumer spending, the data pointed to a tough month ahead for the world’s second-largest economy as President Xi Jinping’s government’s efforts to to stabilize the property sector and to avoid deflation have shown little effect. .
Housing market challenges were evident in price data for September, which showed prices of new homes in major cities fell by the most in almost a year, even as measures to encourage home buying came into effect. power. The large real estate sector shrank 2.7% in the third quarter, the biggest quarterly decline this year, according to China’s statistics bureau.
Source: BNN Bloomberg
We should note here that while the picture below shows the decline, we are still in the second or third place of this result.
Official statistics are also underestimating the size of the fall, perhaps knowingly, to prevent a full-scale panic.
Home price data in many countries is based on total market transactions, however China uses selective samples,” said Chin, head of Asia Pacific research at CBRE Group Inc. “When a market falls, the true state of the market is difficult to be reflected in such data”.
In Hangzhou, near where Alibaba is headquartered, house prices in some neighborhoods have fallen 25% to 28% from a peak around October 2021, agents said. In Lianyang, a downtown area popular with expats and financiers in Shanghai, housing prices have fallen 15% to 20% from record highs in mid-2021, they said.
Major cities, once considered resilient to the housing downturn, are not immune. Prices of existing homes in at least five popular Shenzhen districts have fallen 15% in the past three years, according to a July report by property research institute Leyoujia. The southern center is the country less affordable the housing market.
All data sources in China, whether government or private, face “significant challenges” in compiling a portfolio that is relatively stable for tracking house prices, Goldman Sachs China economists wrote in a July report. led by Wang Lisheng. In their assessment of China’s house price measures, they said there is no “perfect” measure.
We think this is the biggest bubble known to man, the fallout will last at least a decade as assets reprice into consumer incomes. Retail sales remain vulnerable in such an environment. BABA maintains stable profitability and high margins, compared to other online retailers such as JD.com (JD).
But this can be a problem in a weak economy as people are price conscious. BABA’s valuations here still look bullish on what lies ahead.
More disappointments are expected in 2024.
BABA was “free” when we first wrote about it.
Of course, now it is even cheaper. We showed the price for the sales multiple earlier in the article and now we are showing the price for the tangible book multiple.
This is compounded as BABA has accumulated tons of cash and investments on its balance sheet. That adds another buffer to the bull case here, and BABA remains poised to put tremendous amounts of cash flow toward shareholder returns relative to its market capitalization. The recently announced inaugural dividend was another step in the right direction. The stock has long-term potential here, despite some headwinds. It has become a value play, from an extraordinary growth stock. Nothing says it won’t become an even bigger value play as tax loss harvesting takes place. We continue to believe that covered calls will outperform equity over the long term and therefore rate this as a hold.
Please note that this is not financial advice. It may look like it, it may sound like it, but surprisingly it is not. Investors are expected to do their due diligence and consult with a professional who knows their objectives and limitations.
Editor’s Note: This article discusses one or more securities that are not traded on a major U.S. stock exchange. Please be aware of the risks associated with these stocks.