Alibaba: This Rally Has Legs (NYSE:BABA)

Over the last year, I have written several articles on Alibaba (NYSE:BABA), the Chinese tech conglomerate. Despite wild price swings and shares bottoming out below $60 in October, I have stayed bullish the whole way. While I will be the first to admit that it was painful to watch shares drop consistently in 2021 and 2022, it was a reminder that it’s only a loss on paper until you sell and realize that loss. It’s one thing to sell and cut your losses when the investment thesis breaks, but I didn’t (and still haven’t) see any signs that the thesis on Alibaba was broken. The sentiment was driving the price down, and I’m patient enough to wait for that to turn around. In the last three months, it seems like that sentiment has changed, with China’s reopening and a massive rally in Alibaba’s shares.

Investment Thesis

Alibaba has been a dog for me in the last couple years, as I rode shares all the way down to the trough below $60 and back up again without selling a share. Things have started to look up for Alibaba and its shareholders as the Chinese economy is reopening due the abandonment of the zero-COVID government policy. In recent weeks, there have been several developments, including golden share arrangements and Jack Ma relinquishing control of the Ant Group subsidiary, which Alibaba owns a 1/3 stake. Activist investor Ryan Cohen recently announced his own stake in Alibaba and is pushing for more buybacks.

I like the company’s buyback program which has been put to good use in recent quarters, but I would lean towards new investments instead of more buybacks in the future, especially if the share price continues to rally. Despite the fact that shares have basically doubled off the bottom, shares are still attractive today just over 15x earnings. It’s not as cheap as it was, but if you look at the company’s balance sheet and subsidiaries, I still think there is significant upside for patient investors. Sentiment has continued to improve in the last couple months, and while I might be a bit biased, I think the current rally has legs.

A Couple Recent Developments

Alibaba should be releasing its Q3 earnings soon, but there have been a couple of things that have happened since my last article that are worth mentioning. The first thing I wanted to touch on was the golden share news from a couple weeks ago. The regulatory environment is something to be aware with any Chinese company, but one of the recent developments I found interesting was the golden share arrangements with a couple of Alibaba’s subsidiaries. The Chinese government, through different investment vehicles, now has a 1% stake in the Youku Film and Television segment and the Guangzhou Lujiao segment. These stakes typically come with board representation and veto power over certain actions.

Another development from early January has to do with Alibaba’s 1/3 stake in Ant Group. Jack Ma has relinquished control of the Ant Group subsidiary. Anyone following Alibaba’s stock will be familiar with what happened in 2020 as shares peaked. Ant Group was set for a huge IPO until Ma was vocally critical of the Chinese government in a speech. I’m curious to see what happens with Ant Group in the future, because it has massive market share in the Chinese fintech market. While Ma still has a say in things, he won’t have complete control.

The last (and probably least important) thing that happened is that Ryan Cohen recently took a stake in Alibaba and is pushing for more buybacks. Alibaba already bumped its buyback authorization with its most recent quarterly report by $15B.

Cohen has told Alibaba’s board that it could further increase its repurchase plan by another $20 billion to a total of $60 billion, according to the WSJ report.

I do like the buyback program, especially since they have been putting it to good use in the last few quarters at a cheap valuation, but I would rather see them invest in future growth, especially if the share price keeps rising from here.

Valuation

Alibaba has spent much of the last two years trading with the so-called “China Discount”. While their government (and Alibaba’s ADR share structure) does create additional risk, I think the potential reward far outweighs the potential risk. Outside of the selloff that started in the fall of 2020, Alibaba has pretty closely tracked the 30x earnings line. Shares now trade at about half that, with a price to earnings multiple of 15.2x.

Do I think Alibaba returns to 30x earnings? Maybe, maybe not. However, if you look at the cash on the balance sheet and investments in Ant Financial, 15x earnings looks like a steal to me, even if it’s not as cheap as it was three months ago. My cost basis just below $160, so I’m still underwater, but it’s not as ugly as it was three months ago. I haven’t added to my position in a long time because I have been putting my money to work in other ideas, but I still think Alibaba has the potential to provide outsized returns for investors from here.

Conclusion

I’m looking forward to the next quarterly report and the annual report which will be coming this spring. My guess is that Alibaba will benefit from the reopening of the Chinese economy, but I think the share price will continue to be driven by sentiment in the short term. Since the reopening only got started in recent weeks, it likely won’t show up in the upcoming quarterly report, but moving forward, I think we will see business improve for Alibaba across the board.

Barring any unforeseen government interventions or economic collapses, I think we will see Alibaba shares continue to grind higher. The company’s business segments are well positioned for a Chinese economy that is reopening, and I’m excited to see what the cloud segment can do in the next three to five years as the leader in the Chinese cloud market.

I do think we will see margins improve in the next year as revenue starts to grow again and business picks up as the Chinese economy fires back up. I will be keeping an eye on the golden share arrangement and the Ant Group subsidiary, but I think shares will be trading higher twelve months from now. While Ryan Cohen’s new stake brings publicity, I have mixed feelings about boosting the buyback program at the current price, especially if there are attractive alternatives for investment. With shares trading just above 15x earnings and growth projected to be solid in coming years, I still think Alibaba provides a solid risk/reward for investors. The huge move in share price over the last three months might make some investors avoid the stock, but I think we will see continued momentum in shares of Alibaba in 2023.