Alibaba Continues To Benefit As The World Goes Digital (NYSE:BABA)

Introduction

My thesis is that Alibaba (NYSE:BABA) continues to benefit as the world goes digital.

At the time of this writing, RMB 100 is about $15.

A Digital World

Some in the West say that Beijing picks winners, but the Cashless Revolution book by Martin Chorzempa shows that Alibaba succeeds because they enable the flow of commerce through digital offerings. Thanks to Alibaba, small merchants can easily sell goods online or through their brick and mortar stores without being stifled by high payment fees. Alibaba hasn’t just changed commerce in China, they are spreading to other parts of Asia. Author Chorzempa talks about his 2017 honeymoon in Thailand, saying that despite credit card signs, merchants sometimes told customers that they only accepted Alipay or Thai Baht.

In the 2Q23 call through September 2022, CEO Yong Zhang notes that being digital is part of Alibaba’s DNA. They offer digital solutions for both online and offline commerce. They have also brought an asset-light digitalization approach to their logistics arm, Cainiao. Over 70% of Cainiao’s revenue now comes from external offerings, and it is one of the reasons why CEO Zhang said China is probably the #1 country in the world for express delivery services, both in volume and quality.

The Financial Times reported that China is taking shares in interests tied to Alibaba and Tencent (OTCPK:TCEHY). Per the Wall Street Journal, this is a sign that the two-year clampdown on big tech is coming to an end as the government recognizes the “significant and irreplaceable contributions” Alibaba makes to cities like Hangzhou.

Valuation

In the call for the period through September 2022, management telegraphed the fact that they thought the stock was cheap from April 2022 to November 16th of 2022:

Importantly, on the current market conditions and given the confidence we have in the long-term sustainability of our business, we have been repurchasing our shares aggressively. For fiscal first half ended September 30th, 2022, we repurchased approximately 62.9 million of our ADS for approximately $5.6 billion, which is equivalent to about 70% of our free cash flow during the period. From October 1st to November 16th, we have repurchased another $2.6 billion in ADS on our share repurchase program. Our strong balance sheet and free cash flow give us the flexibility to execute this share repurchase program with confidence.

Alibaba’s free cash flow (“FCF”) is now prodigious as it has climbed from RMB 8,752 million in FY12 to RMB 98,874 million in FY22:

One reason for the FCF decline from FY21 to FY22 in the graph above was the fact that the accrued expenses, accounts payable and other liabilities line added RMB 74,554 million to net cash provided by operating activities in FY21 while this addition was just RMB 13,327 million in FY22.

Stock based compensation (“SBC”) is another factor in the drop of FCF from FY21 to FY22, and it deserves special mention. SBC dropped from RMB 50,120 million in FY21 to RMB 23,971 million in FY22 and this is a non-cash expense, so it means net cash provided by operating activities got RMB 50,120 million added back in during FY21 while it only got RMB 23,971 million added back in during FY22 for a difference of more than RMB 25 billion. Typically, existing shareholders do not like to see declines in FCF, but this SBC situation is actually a good thing for existing shareholders as SBC is becoming a smaller percentage of revenue and existing shareholders aren’t being hurt as much by SBC dilution.

Here is the operating activities part of the cash flow statement with the accrued expenses, accounts payable and other liabilities line and the share-based compensation line:

From an economic standpoint, I think of SBC as a cash expense, such that the FCF figures above are overstated when we use FCF as a proxy as to how much money can be pulled out of the business. SBC was RMB 31,742 million, RMB 50,120 million and RMB 23,971 million for FY20, FY21 and FY22, respectively which amounted to 6.2%, 7.0% and 2.8% of revenue, respectively. SBC was RMB 14,512 million for the 6 months through September 2022 which came to 3.5% of the RMB 412,731 million revenue. There are also factors that make the above FCF figures understated, such as growth investments embedded in both income statement lines and capex.

Looking at the FY23 interim report through September 2022 and the annual report through March 2022, trailing-twelve-months (“TTM”) FCF through September 2022 was RMB 113,834 million or $17.1 billion from RMB 57,882 million 6M23 + RMB 98,874 million FY22 – RMB 42,922 million 6M22.

Despite the fact that the FCF margin has decreased over the years, it is still well above the level we see at Amazon when AWS and Alibaba Cloud are excluded. Part of the reason for this is that Alibaba has an asset-light approach with their digital logistics offerings.

TTM operating income excluding goodwill amortization through September 2022 was RMB 98,507 million or RMB 55,560 million 6M23 + RMB 94,779 million FY22 – RMB 51,832 million 6M22.

TTM revenue through September 2022 was RMB 859,363 million or RMB 412,731 million 6M23 + RMB 853,062 million FY22 – RMB 406,430 million 6M22.

I believe Alibaba is worth 20 to 21x the TTM FCF of $17.1 billion, or roughly $340 to $360 billion.

The September 2022 release says there were about 21 billion ordinary shares outstanding as of September, which equates to about 2.6 billion ADSs. Multiplying the 21 billion ordinary shares by the January 13th ADS price of $117.01 and dividing by 8 gives us a market cap of nearly $310 billion. Not counting long-term investments, the enterprise value is about $27 billion less than the market cap due to $29,059 million cash and equivalents plus $37,979 million short-term investments which are only partially offset by $930 million short-term debt $701 million short-term notes, $6,895 million long-term debt, $14,169 million long-term notes and $17,546 million noncontrolling interests.

The market cap is less than my valuation range, and I think the stock is undervalued for long-term investors.