Don't Worry About Delisting, Alibaba Is A Buy
- Alibaba's shares came under pressure due to a bill that could theoretically lead to a NASDAQ delisting.
- Delisting is not very likely, and it would not matter too much in the long run anyways.
- Alibaba operates a very attractive business and generates strong growth.
- Relative to the growth that Alibaba generates, shares do look attractively priced.
- This idea was discussed in more depth with members of my private investing community, Cash Flow Kingdom. Get started today »
Alibaba (NYSE:BABA) has been in the news a lot recently, due to the renewed China-US tensions and some moves by the US administration that could potentially lead to a delisting of Alibaba and other Chinese stocks (FXI) on American stock exchanges. This is, however, not too much of a worry we believe.
Meanwhile, Alibaba continues to grow its business profitably, more and more becoming a gigantic and highly profitable conglomerate in the world's most populous country. We see it as a more attractive, less expensive alternative to Amazon (AMZN), and due to its dominance in China, the long-term outlook for Alibaba's shares is positive.
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Politicians' Talk About Delisting Alibaba & Co
Due to the COVID-19 pandemic and other factors, tensions between the US and China have flared up again over the recent past, following the positive deescalating impact of the phase 1 trade deal at the beginning of the current year. This has resulted in more aggressive rhetoric on both sides, and ultimately the US Senate passed a bill that would impose more strict regulation on Chinese companies that are listed in the US.
Forbes summarizes the bill like this:
The Senate passed a bill on Wednesday that will force Chinese companies to abide by the same rules as American (and Brazilian, and Mexican, and Russian, etc) listed on New York Stock Exchange and Nasdaq.
Part of the action includes delisting companies controlled by the government, such as PetroChina (PTR).
At first sight, this does not seem like an unreasonable proposal -- why would Chinese companies be treated differently than companies from other foreign countries? There is, however, an implication that the threat of delisting could be used rather liberally by US administration on the basis that many, or even most Chinese companies are more or less controlled (in the sense of heavily influenced) by the government. It should be noted that the above bill was also partially driven by bad experiences made with Luckin Coffee (LK), which had cooked the books massively. It is not yet known if/when this bill will be made a law, and it is entirely possible that it will never be passed by Congress.
Even if this gets passed, however, the impact on Alibaba would likely not be too large. Alibaba may avoid delisting if authorities focus on companies where the Chinese government holds a lot of power, such as PetroChina. And even if Alibaba were to delist, this would not make the company worthless -- in fact, the value of the underlying business does not change based on the listing or delisting on a specific stock exchange. If Alibaba were barred from being listed in the US, which seems like an unlikely scenario, there would be the possibility for Alibaba and other large Chinese companies to list on London's stock exchange instead. Investors from the US and other countries in the hemisphere would thus still have the option to invest in Alibaba and other Chinese mega corps through a reputable, highly liquid stock exchange.
In short, we see this as not too much of a headwind in the short term, as Alibaba will, we believe, not be delisted. At the same time, the long-term impact of this bill should be even smaller -- even in a scenario where shares get delisted, the value of the business does not change in the long run.
Alibaba -- A Better Version Of Amazon?
A better business model
Alibaba is oftentimes called a Chinese version of Amazon, although that is not really an accurate description. The business models of the two companies are somewhat different, as Amazon operates on a business-to-consumer basis, doing a lot of the selling and delivering of the products that customers buy themselves. Alibaba is more of a business-to-business platform that allows two parties to make a deal, where it takes a cut without handling any of the products itself.
Not having to actually handle any products means that Alibaba needs a lower number of employees, fewer facilities, there are fewer transportation requirements, etc. It is merely a platform whereas Amazon is both a platform and a highly sophisticated warehousing and logistics operation. This is why Alibaba's cut is smaller than Amazon's, but its margins are much higher.
Alibaba generates almost half a dollar in gross profits for every dollar in revenues that the company generates, and its operating profit margin is more than 3.5 times as high as that of Amazon. This is a very durable advantage that will most likely never go away, as this is caused by the (in our mind) more attractive business model. That is not everything, though, the company also has better liquidity, is operating more efficiently, and generates higher returns with its assets:
Alibaba's current ratio is almost twice as high as that of Amazon, which can be explained by the fact that Alibaba does not need any meaningful inventories which are normally financed via accounts payable positions. Alibaba's asset turnover is much stronger than that of Amazon as well, as Alibaba does not need to hold a large number of assets such as fulfillment centers, warehouses, etc. Last but not least, Alibaba's more efficient use of its assets and its stronger margins allow the company to generate a return on assets that is easily more than twice as high as that of Amazon.
Amazon does not necessarily have a bad business model, we believe, but Alibaba's platform approach where it is the middleman that connects sellers and buyers is a much more attractive business model.
On top of that, Alibaba provides investors with great exposure to the world's leading e-commerce market, which is China, plus some additional exposure in other countries such as India, Russia, and Thailand. The Chinese economy is not as large as the US economy, but China has moved to online sales to a larger degree already, which is why total e-commerce sales in China are almost twice as high as those in the US. Buying the number 1 player in the world's largest market, with additional exposure to other higher-growth markets in the same region, sounds more attractive than buying the number 1 player in the world's second-largest market.
A better approach to M&A
On top of all of this, Alibaba's management also seems to be more sophisticated when it comes to choosing the right takeover targets. Amazon has made a range of purchases in the past, including companies such as Twitch and Whole Foods (for $13 billion). So far, these acquisitions have not generated any hefty returns, though, and it looks like Amazon may have actually tried too hard when it bought Whole Foods.
Contrast this with Alibaba's acquisition and investments in companies such as Lazada (e-commerce in Southeast Asia, Youku (video entertainment company from China), Ele.me (online food delivery platform), and many more. These acquisitions seem more logical and are mostly centered around expanding Alibaba's geographic reach by adding other Asian countries to its sphere. Or, in some cases, they aim towards bringing Alibaba's existing customers deeper into its "web" by giving them additional online-based services that the company controls. To us, this looks like a more logical approach towards M&A compared to Amazon's investments, where a common thread is hard(er) to find.
Alibaba Is Not Expensive Relative To The Growth It Generates
High-flying tech stocks with strong growth rates and wide moats seldomly trade hands for low valuations, and Alibaba also is not especially cheap on an absolute basis. Relative to the growth the company generates, however, shares do also not really look expensive:
Alibaba's shares trade at 22 times trailing free cash flows, which results in a free cash flow yield of 4.5%. This is not an overly expensive valuation in absolute terms, and for a high-growth stock like Alibaba, this seems rather inexpensive. Shares are also trading for just below 20 times next year's expected net profits. Since analysts are forecasting long-term earnings per share growth of 19%, Alibaba is trading with a (2021) PEG ratio of ~1, which sounds very reasonable.
Contrast this with US-based mega tech companies such as Amazon or Microsoft (MSFT), which trade at what we deem quite lofty valuations right here:
Amazon at three times' Alibaba's valuation, just because it is based in the US? This is not a deal that seems attractive. Microsoft is significantly less expensive than Amazon but still trades at a large premium to Alibaba, even though the long-term EPS growth estimate for Microsoft is worse, at 13% a year (per YCharts).
Risks To Consider
We don’t expect Alibaba to be delisted from the NASDAQ, but if it were, this would have no impact on the company’s business model or underlying profitability. It probably would temporarily impact stock prices and the multiple paid due to short-term selling pressure, though. Also, some ETFs and other large institutional investors would likely be forced to liquidate positions. This could theoretically lead to a somewhat lower long-term multiple. We acknowledge there is a chance a delisting happens, but think it a low probability. Investors could choose to deal with this risk by stepping into any position over time via multiple purchases.
There are still some other risks to also consider, however. Most of these are not company-specific since Alibaba has a wide moat and very stable financials, but due to being based in China, there is an array of macro risks investors should keep an eye on.
The first one is that regulatory oversight in Chinese companies is not comparable to the oversight in US-based companies, and the rights of small shareholders in Chinese companies are quite finite. Alibaba will have to bend to the Chinese Politburo Standing Committee’s will, which will not necessarily make economic sense. Alibaba's most important market is not a free & liberal democracy governed by impartial laws. Though China has experienced huge economic growth in the past, political turmoil interfering with the firm’s economic operations cannot be ruled out.
Confrontations between the US & China continuing to escalate and affecting the firm’s operations are a possibility as well. Possible reasons for confrontation range from Hong Kong protests to trade deal worries, and over time, things we may not yet be aware of could come up on top of that. Should tensions rise, this could continue to pressure the valuations of China-based companies, which could lead to share price declines. These share price declines could occur even though Alibaba's underlying business would likely not suffer too much, as Alibaba's business is not really dependent on a lot of trade with the US.
The Senate passed a bill that potentially could lead to Alibaba being targeted, but the risk of delisting is not judged likely. First, the bill hasn’t become law yet, and second, additional confrontation isn't really in the US' (or China’s) best interest.
We deem Alibaba's business model quite attractive over the long run, and although not an absolute bargain, shares are trading at a very reasonable valuation right now. Relative to the market position, wide moat, and expected growth, shares look attractively priced right here.
Among mega-cap tech stocks, Alibaba is one of the most attractive picks, which is why we see it as a much more favorable pick compared to Amazon and other mega-cap tech stocks that look too expensive.
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