wonry
Alibaba (NYSE:BABA) and Tencent (OTCPK:TCEHY) released earnings this week, and rallied after surpassing analysts’ expectations. Tencent beat on earnings but missed on sales, Alibaba was in pretty much the same boat.
The rallies after BABA and Tencent’s releases were large. Both rose more than 5% after their releases came out, but gave up a portion of the gains on Friday. Alibaba rallied 7.5% on Thursday alone.
If you own Chinese stocks through an ETF, you probably enjoyed what you saw in this week’s earnings reports. Chinese companies beat expectations, and most of them delivered positive growth. For the passive investor, it was a slam-dunk earnings season: few would sell the Chinese market based on what they saw last week.
For the stock picker, the matter is more complex. If you’re trying to decide between individual positions in Alibaba or Tencent, you need to look at each company’s financials side by side, and decide which is best. You have to look at not only their earnings, but also their long term financial trends, competitive positions, and more. It’s not easy to compare companies side by side like this; in many cases, you find that one company wins in one category, while its competitor wins in another. Indeed, Alibaba and Tencent do have their own specific strengths and weaknesses, but after closely scrutinizing the companies’ recent earnings, I’m convinced that the former company is a slightly better buy. In this article, I will show how I came to that conclusion, focusing on the fact that Alibaba is cheaper while having better financials than Tencent in basically every category.
Business Focus
One difference between Alibaba and Tencent is the percentage of their revenue coming from foreign (non-Chinese) markets. Only 7% of Alibaba’s revenue comes from international sources, in Tencent’s case it’s 8%. This comparison favors Tencent. The U.S. dollar is gaining on the Yuan this year; U.S. dollar exposure creates Forex gains for both companies, but Tencent gets a higher percentage impact than Alibaba does.
To explain how this works briefly:
Every multinational company has several different currencies it works with:
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Presentation currency – the currency it reports in.
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Functional currency – the currency where it makes money.
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Local currency – the currency where the company is located (often the same as functional).
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Foreign currency – a currency other than the functional one.
When a foreign currency gains against your presentation currency, and you make money in that foreign market, you profit off it–at least in nominal terms. If you report your results in Yuan, and you make 8% of your money in the U.S., and the U.S. dollar appreciates, you get to report more Yuan earnings. Tencent does more U.S. dollar revenue than Alibaba does, so it gets a bigger benefit from dollar strength.
Financials
Next up we can compare Alibaba and Tencent in terms of financials–including earnings, cash flows, and balance sheet items.
Select items from Alibaba and Tencent’s most recent income and cash flow statements are shown below. I’ll do a separate table for balance sheets later, because that’s a fundamentally different thing that is not really about periodic performance.
|
Alibaba |
Tencent |
|
|
Revenue |
$29.12, up 3%. |
$19.7 billion, down 2%. |
|
GAAP earnings |
$-2.8 billion. |
$5.5 billion, down 3%. |
|
Adjusted earnings |
$1.86 per share, up 15%. |
$4.7 billion, up 3%. |
|
Operating income (“EBIT”) |
$3.5 billion, up 21.5%. |
$5.8 billion, unchanged. |
|
Free cash flow |
$5.02 billion, up 63%. |
$3.88 billion. |
As you can see, Alibaba’s bottom line metrics mostly grew, while Tencent’s mostly declined. So, Alibaba takes the cake on growth.
As for financial health: Alibaba was negatively impacted by two factors in the quarter just reported:
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Declines in its stock portfolio.
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Stock based compensation.
The stock portfolio effect is pretty simple to explain: under GAAP accounting rules, if your stocks go down, then your bottom line income goes down by that amount. It’s subtracted from your operating income along with taxes to get to net income.
Stock based compensation is a little more complex. The amount of SBC a company records in a period is defined by this formula:
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Unrecognized options divided by remaining vesting period.
So, if you have $1000 in SBC still to vest, and the employees have two years left to go, you record $500 in SBC today. The actual cash impact won’t necessarily always work out as this formula predicts, because sometimes employees quit before their options vest.
The point is, BABA’s GAAP earnings were reduced by non-cash factors. If you take the stock portfolio swings out of the equation, you get a very healthy $1.86 in earnings per share.
Now, let’s look at some key balance sheet metrics for Alibaba and Tencent:
|
Alibaba |
Tencent |
|
|
Assets |
$240.7 billion |
$207 billion |
|
Liabilities |
$89.9 billion |
$92 billion |
|
Equity |
$150 billion |
$106 billion |
|
Fixed assets |
$145 billion |
$149 billion |
|
Current assets |
$92.5 billion |
$58.2 billion |
|
Current liabilities |
$53.8 billion |
$40 billion |
|
Long term debt |
$21 billion |
$45 billion |
Some ratios we get for BABA include:
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Debt/equity: 0.14 (excellent, below 1 is considered ideal).
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Current ratio: 2.56 (also excellent, above 1 is considered ideal.
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Fixed asset turnover: 0.2 (not amazing, higher is better with this one).
Now, for Tencent we get:
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A 0.42 debt/equity ratio (higher than BABA).
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A 1.42 current ratio (lower than BABA).
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A 0.132 fixed asset turnover ratio (lower than BABA).
Remember that with debt/equity you want a low ratio, but with current and fixed asset you want high ratios. So, it’s no contest: Alibaba has a healthier balance sheet than Tencent, based on the handful of metrics sampled here.
Risk
As we’ve seen, Alibaba has got Tencent beaten on growth and balance sheet health, putting it in the lead so far. However, we aren’t done. There are many other non-financial factors we need to look at, and they could impact financials down the line.
A big one is presence in foreign markets. Both Alibaba and Tencent are already huge players in China, so their future depends quite a bit on growing overseas. Tencent wins in this category so far: it gets 8% of its revenue abroad, compared to 7% for Alibaba. Tencent owns some of the world’s most popular gaming franchises, such as Fortnite (through its 40% stake in Epic Games), League of Legends (through Riot Games), and others. Most gamers have played Tencent titles whether they know it or not. Alibaba is a pretty niche service outside of China and some other Asian markets, mainly known to drop shippers. So, Tencent has less geographic concentration risk than Alibaba does.
Another risk factor is competition. Alibaba faces competitive pressure from JD.com (JD) and Pinduoduo (PDD), which are growing their sales faster than BABA is. BABA has much bigger margins than those companies do, but still, their rising sales have the potential to take sales away from Alibaba. By contrast, Tencent owns large stakes in most of its competitors, so it benefits from their success. Therefore, it looks like Tencent has a better competitive position than Alibaba does.
Finally, there’s the matter of regulations. Regulatory risk ran high for Chinese stocks back in 2021, when China handed out fines and issued Draconian rules left and right. Both Tencent and Alibaba were affected. BABA took a $2.8 billion fine, while Tencent suffered from restrictions on how many hours a week kids could play games. The impacts to both companies were substantial, so I’ll call it a draw on this factor.
The Final Verdict – Alibaba is Slightly Better Than Tencent
While both Alibaba and Tencent have a lot going for them, BABA looks like a better buy today. Its margins are higher, its growth is higher, and it has a much healthier balance sheet. Sure, Tencent managed to buy many of its competitors, but that hasn’t translated to amazing financial performance, at least not compared to Alibaba. BABA is growing and has a fantastic balance sheet, Tencent is shrinking and has a good-but-not great balance sheet.
If you need another factor to tip the scales, you can look at valuation. As I’ve mentioned in past articles, BABA trades at around 11 times adjusted earnings, 1.5 times book value, and 10 times operating cash flow. By contrast, you have Tencent with a 23 P/E ratio, a 3.3 price/book ratio, and a truly hefty 4.5 price/sales ratio. So BABA is growing faster and is cheaper than Tencent.
I do not mean to disparage Tencent by pointing these things out. It’s a great company, but Alibaba has basically every financial advantage over it. Tencent’s advantages mainly lie in soft factors, like its foreign presence, and its neutralizing of competitors by buying them out. When it comes to earnings, cash flows and assets, Alibaba wins.
Does that mean you should necessarily buy Alibaba instead of Tencent? No. Everybody should buy assets that they understand; if you’re a hardcore gamer who never shops online, then you’re probably better positioned to make an informed investment in Tencent than in BABA. It’s definitely true that Alibaba has better financials than Tencent, but that doesn’t mean that Alibaba is a suitable stock for everyone.
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