Alibaba Stock: Charlie Munger Capitulates (NYSE:BABA)

In 2021, Charlie Munger became one of the most prominent Alibaba (NYSE:BABA) bulls. His Daily Journal Corporation (DJCO) owned ~600,000 ADRs in the Chinese-based company at the end of 2021, but the latest filing revealed that the overall position has been slashed in half and at the end of March was only 300,000 shares. While Charlie Munger rationalized the ownership in Alibaba using traditional valuation metrics and looking at its market potential, the direct and indirect interferences of Beijing in the company’s affairs prevented the growth of the stock and forced large investors to cut their losses. Since the publication of my article titled Alibaba: Charlie Munger Is Wrong Again in late November, Alibaba’s shares depreciated by ~30% and there’s no indication that the stock will significantly rebound anytime soon.

Even though Daily Journal still owns a big position in Alibaba, the decision to cut the ownership in half could be viewed as a loss of confidence in the company’s ability to perform well in the current environment since it would’ve made no sense to sell shares when they trade at a significant discount to its western peers. For that reason, the goal of this article is to analyze why things didn’t go so well for Charlie Munger and the Daily Journal, and whether there’s any value left for Alibaba at the current price without repeating the arguments that I’ve highlighted in my other pieces on the company.

The Daily Journal Trade

It all started more than a year ago when Charlie Munger’s Daily Journal revealed that it opened a position in Alibaba in the first quarter of 2021. In the following quarters the number of shares owned has been increasing and at the end of December Daily Journal already owned 602,000 Alibaba shares. During that time, the stock has been deprecating and if at the beginning of 2021, it was trading at ~$240 per share, then at the end of the year it was trading at ~$120 per share, which resulted in a serious unrealized loss for Daily Journal’s portfolio.

Everything has changed in the first quarter of 2022. The recent Daily Journal filing showed that at the end of March, it had only 300,000 Alibaba shares in its portfolio, which means that half of the stake has been slashed in the first three months of the current year. Some rumors started to surface that it wasn’t Charlie Munger, who made the decision, as he stepped down as Daily Journal chairman on March 28. However, it seems highly unlikely that Daily Journal sold 302,000 out of its 602,000 shares in the last couple of days of March, since it would’ve significantly pushed the price lower and such a move would’ve been noticed by the market.

In addition, some are saying that Daily Journal sold half of the stake on NYSE and later repurchased it on the Hong Kong stock exchange. However, it doesn’t make much sense as well. First of all, Alibaba’s shares on the Hong Kong exchange are also represented in a form of a variable interest entity (VIE), which doesn’t give direct ownership of the company, and it also makes no sense to transfer only half of the position to the other exchange and leave the other where it is. So at this point, it’s only speculation, while the fact remains that Daily Journal suffered significant losses by buying Alibaba throughout all of 2021 and it no longer holds half of the shares that it owned at the end of 2021.

What Went Wrong?

Charlie Munger has a great record of investing in undervalued businesses and generating great returns over long periods. However, most of the companies in which Charlie Munger invested either through Daily Journal or Berkshire Hathaway (BRK.A) (BRK.B) were American. There were only a few foreign investments such as BYD (OTCPK:BYDDY) (OTCPK:BYDDF), which also yielded decent returns over years. Other than that, Charlie Munger has made his fortune at home.

One of the major justifications for buying Alibaba was the fact that the company’s stock trades much cheaper in comparison to its western peers. The reality is that he’s indeed correct. Currently, Alibaba trades at only 2 times its forward sales, while western tech behemoths such as Amazon (AMZN) and Apple (AAPL) trade at ~3x and ~7x their forward sales, respectively. However, Alibaba also operates in a more unfriendly environment, which justifies its lower premium and is one of the main reasons why it’ll likely continue to trade cheaply going forward.

Let’s not forget that Daily Journal opened its initial stake in Alibaba after Beijing’s crackdown has already begun. While it made sense to purchase the company’s shares purely based on the fundamentals a year ago since the stock has depreciated by over 20% from its highs, the environment in which the company has operated all the previous years has already completely changed at that time. The problem was that Alibaba became too powerful and too political in China and in authoritarian and totalitarian regimes, which China currently is with a one-party rule, any subject that becomes too powerful historically is neutralized. As a result, it becomes absolutely impossible to ignore politics when investing in companies that operate in countries with flawed justice systems, where the ruling party can interpret laws at its own discretion to reach its political goals. That one mistake alone cost Daily Journal a significant amount of money.

In addition, while the crackdown by Beijing against Alibaba started more than a year ago, it continues to this day. After paying a record fine of $2.8 billion to the state, Alibaba is now also required to pay more in taxes (effective tax rate of 10% before vs. 33% in Q3’22), while ~20% of its liquidity is going to be invested into Beijing’s Common Prosperity fund. Also, the recently implemented regulation regarding algorithms could prevent Alibaba from generating significant profits from the digital advertising business, while Beijing directly aims at breaking its dominance in the cloud and digital payment businesses. Considering all of this, it becomes significantly harder even for investors such as Charlie Munger to forecast in which direction the business will go and how much revenue it will generate since the answers to those questions are only known in Beijing.

Is There Any Value Left?

Given the toxic environment in which Alibaba operates, it becomes harder with each day to see a light at the end of the tunnel. The story of Alibaba right now is the story of state interference and there’s no indication that that interference will stop anytime soon. That’s why in my article titled Alibaba: Charlie Munger Ignored The Biggest Risk Of Investing In Chinese Tech, which was published in early November, I noted that it’s the political risk that pushes Alibaba’s stock lower and the company has no control over it. Since that time, Alibaba’s stock depreciated by ~40%.

Nothing has changed since that time and that’s why it’s hard to put any value at all on Alibaba right now. No matter how many times bullish investors will be saying that Alibaba is a bargain at the current price based on P/E, P/S, and other traditional valuation metrics, the reality is that those metrics don’t matter at this stage. According to different multiples, Alibaba was already cheap when it traded at $250 per share, $200 per share, $150 per share, and especially now at ~$100 per share. However, it didn’t stop the stock from depreciating even more. That’s why I’m not optimistic about the company’s latest plan to spend $25 billion on share buybacks since the political risk hasn’t disappeared.

It could’ve been possible to justify buying Alibaba if it was operating in the United States for example, solely due to the completely different power dynamics that we see in America. For years, there were talks of breaking the Big Tech monopoly, yet Apple, Meta (FB), Alphabet (GOOG) (GOOGL), and others continue to expand and thrive as conglomerates. Even the European Union has been more successful in regulating American Big Tech than the United States itself. That’s why it was hard even for Charlie Munger to predict how far Beijing will go on its crusade to regulate the country’s biggest tech behemoth since throughout his life most of his portfolio consisted of American businesses that operated in a completely transparent environment where it was hard to take aggressive actions against the private sector. It’s completely different in China.

What’s worse is that the resurgence of Covid-19 in China along with the prolonged effect of a property crisis due to the collapse of Evergrande that started last year will have a direct negative effect on China’s economy. The Chinese officials already predict the lowest growth of the economy in decades and Alibaba has already disappointed its investors when it missed its revenue and GAAP EPS estimates for Q3, which it reported in late February. With these new developments, Alibaba now has even fewer opportunities to drive growth and significantly improve the state of its business. Add to that the upcoming elections in China, and it becomes certain that Beijing won’t back off anytime soon.

The Bottom Line

There’s no denying that Charlie Munger is an investment legend. I’m sure that a lot of us learned investing by reading Poor Charlie’s Almanack in our free time and most of us will likely never going to have the same successful track record in our lifetime that Charlie Munger had. However, even the greatest could be wrong sometimes. By slashing half of its investment in Alibaba after holding it only for slightly more than a year, Charlie Munger along with Daily Journal signaled that the Chinese behemoth is not that attractive to own even at the current price. The constant interference of the state makes it impossible to predict what will happen to the underlying business and that’s why it’s hard to call Alibaba a value or a growth play. That’s also the main reason why I continue to believe that it’s hard to justify a long-term long position in the company as long as Beijing continues to call all the shots.