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Oct. 18, 2021 9:30 AM ETAlibaba Group Holding Limited (BABA), BABAF14 Comments5 Likes

Ahan Vashi

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FollowLong Only, Growth At A Reasonable Price, Long-Term Horizon, Research AnalystContributor Since 2020Ahan Vashi is the lead equity research associate at L.A. Stevens Investment LLC's Seeking Alpha Marketplace service - Beating The Market. He is a "Quantamental" investor who specializes in identifying market-beating stocks by capitalizing momentum of business fundamentals. Some of his top picks include Upstart at $58, Palantir at $9, and Asana at $22.Prior to joining L.A. Stevens Investments, Ahan worked as an Associate Fellow with Jacmel Growth Partners, a middle-market private equity firm where he acquired the art of analyzing financial statements and business valuation. Ahan holds a Master of Quantitative Finance degree from Rutgers Business School and a Bachelor of Technology degree in Electronics and Communication Engineering from NIT, Surat.At Beating The Market, Ahan works with Louis Stevens, Jared Simons, and one of the most vibrant and dynamic investment communities on earth in pursuit of identifying the next Facebook, Amazon, and Salesforce. Beating The Market brings the potent wealth-creating power of Venture Capital to the public markets. For his part on the team, Ahan does this by systematically analyzing hundreds of public companies each year via BTM's rigorously defined set of 23 standards/criteria - BTM's Crucial Characteristics. In addition to high-growth companies, Ahan works on identifying dividend-growth stocks that can deliver supercharged returns with low volatility via massive capital return programs (dividends and buybacks). Most of Ahan's public articles tend to focus on this area, while his research on high-growth companies is available exclusively to members of Beating The Market. If you'd like "Ahan-lite", check out his Twitter profile here: https://twitter.com/VashiAhanIf you have any questions, feel free to reach out to him via a direct message on SA or leave a comment in one of his articles!Disclosure: Ahan Vashi is a promoting contributor for Louis Stevens' SA Marketplace service - Beating The MarketSummary

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Introduction: A Reversal or A Dead Cat Bounce?

Alibaba's (BABA) shareholders have been a happier bunch over the last few trading sessions after its stock bounced from a multi-year support level around ($140-$150). Technically, the stock is not out of the woods yet as it remains in a downward channel; however, murmurs of a V-shaped recovery for Alibaba are already floating around in popular investment forums like Reddit. When I last wrote on Alibaba in September (Alibaba: An Opportunity Of A Lifetime Or A Tragic Mistake?), the stock was trading at ~$162, and China's government and regulators were attacking Alibaba (and the entire Chinese tech sector) with new fines and regulations almost on a daily basis. However, as its economy falters, the Chinese government seems to be easing on these policy actions. Naturally, Alibaba's stock is bouncing back; however, can this bounce last?

Source: Webull Desktop

With massive uncertainty around Evergrande's debt default, China's real estate market (one-third of its GDP) faces a perilous crash. At this moment, the Chinese government has little room left to punish its technology giants unless they want a full-blown economic crisis ahead of a critical CCP election next year. Hence, I think that Alibaba's regulatory pressures might be easing off for the time being.

A news article on Seeking Alpha reported that Jack Ma (Alibaba's co-founder) made an appearance in Hong Kong recently, which ended a nearly one-year hiatus from the public domain for Ma. Is this a sign that the worse is over for beaten-down Chinese tech stocks like Alibaba? Well, Jack Ma is a strong proponent of an open and market-driven economy, but I do not have an answer for this question because China is a very different country, and its autocratic leadership could spring a surprise at any moment.

We are long-term investors and not swing traders, so I am more concerned with where Alibaba will be in 5-10 years from now and not where it will be in the next two or three months. The complete financial analysis for Alibaba was shared in my previous research note, and so, we will just review the valuation section here before looking at a pretty solid case (or argument) for a long-term investment in Alibaba at current levels.

Alibaba's Fair Value And Expected Returns

To determine Alibaba's fair value, we will employ our proprietary valuation model. Here's what it entails:

Today, Alibaba is generating massive amounts of operational cash flows; however, these numbers may look a lot different if the Chinese government continues its crackdown on technology companies. We will build our model based on current realities without trying to figure out Xi Jinping's next move. According to consensus analyst estimates, Alibaba is poised to record $150B in revenues over the next 12 months on the back of strong performance in its core e-commerce businesses. Over the long term, Alibaba will be able to expand its free cash flow margins to ~25%; however, I must admit that this estimate may not materialize if the Chinese government hampers Alibaba's expansion into higher-margin businesses. The other assumptions are pretty straightforward and self-explanatory.

Assumptions:

Forward 12-month revenue [A] | $150 billion
Potential Free Cash Flow Margin [B] | 25%
Average diluted shares outstanding [C] | ~2.755 billion
Free cash flow per share [ D = (A * B) / C ] | $13.61
Free cash flow per share growth rate | 12.5%
Terminal growth rate | 3%
Years of elevated growth | 10
Total years to stimulate | 100
Discount Rate (Our "Next Best Alternative") | 9.8%Here's the result:

Source: L.A. Stevens Investments ModelBased on its fundamentals, Alibaba is worth ~$505 per share. As of writing, the stock is trading at ~$175, which means Alibaba is undervalued by ~65%. If Alibaba were allowed to conduct business freely in China, my assumptions would prove to be conservative. Therefore, Alibaba may outperform my projections. To calculate the total expected return, we simply grow the above free cash flow per share at the aforementioned conservative growth rate, then assign a conservative Price-to-FCF multiple, i.e., 20x, to it for year-10. FYI, Alibaba was trading at a Price-to-FCF ratio of ~40x in early-2021. Here are the results for Alibaba's expected return:

Source: L.A. Stevens Investments ModelAs you can see above, Alibaba's stock price could grow from ~$175 to ~$1,100 at a CAGR of ~20% in the next ten years. Now, these returns (based on conservative assumptions) are significantly higher than my investment hurdle rate of 15%. Hence, Alibaba looks like a great buy at current valuations based on its business fundamentals.A Sound Case For A Long-Term Investment In AlibabaAlibaba is one of the most innovative technology companies on the face of this planet, with a sprawling business empire that spans retail (online and physical), cloud computing, digital entertainment, and more. Over the last two decades, China's economy has progressed by leaps and bounds, and Alibaba has captured a massive chunk of the internet boom.

Source: Alibaba Investor Day 2020Today, Alibaba is a powerhouse organization that owns multiple growth engines (business lines) which operate at the center of powerful secular growth trends. Now, I acknowledge that China has turned into an unfriendly market for large businesses (including domestic and international organizations); however, the government can only put speed brakes on Alibaba (and the rest of China's tech sector), not stop its engines, simply because they can't afford to kill their own economy.

Source: Alibaba Investor Day 2020Alibaba has made multiple small bets in emerging technologies (IoT, remote collaboration, fintech, etc.) that could become massive revenue streams over coming years; however, e-commerce and cloud computing trends are far from over, and Alibaba remains at the forefront in these massive markets. To make a case for a long-term investment in Alibaba, I think investors do not need to look beyond its retail (online and offline) and cloud computing business lines.As you may already know, China is the largest e-commerce market in the world, with 2021 sales figures expected to come in at ~$2.8T. The adoption of the internet has progressed smoothly over the last couple of decades in China, and today, nearly 70% of China's population has access to the internet. Naturally, e-commerce has been a powerful secular growth trend for several years now, and with China's demographics, it will continue to grow for many more years to come.

Source: shopify.com

Source: shopify.comChina's total retail market is estimated to be worth $5.6T, and Alibaba is a big player in this space, with a reach extending to ~900M consumers in China. Furthermore, Alibaba's retail ecosystem has more than ~265M AACs in international markets. With multiple platforms (like TMall, Taobao, Freshippo, etc.) under its umbrella, Alibaba also possesses strategic ownership interests in rapidly growing e-commerce giants (which are more like "super-apps") in the Southeast Asia region (e.g., Lazada, Tokopedia, and many others).

Source: Alibaba Q2 Earnings PresentationWith more than a billion active users, Alibaba's core retail business (~90% of its total revenue) remains stronger than ever (revenue of ~$150B per year), and luckily, the Chinese government has not attacked this part of Alibaba's business (except for some fines from regulators for monopolistic policies [cost of doing business]). We could see more regulatory actions in the future, but Alibaba's primary business line remains strong for now.While Alibaba's retail business has not been attacked much, we can't say the same about its cloud computing venture. The Chinese government has ordered all state-owned businesses to shift away from private cloud providers like Alibaba, Tencent (OTCPK:TCEHY), and Baidu (NASDAQ:BIDU). At the end of Q2 2021, Alibaba Cloud had a ~34% market share in China's rapidly growing cloud infrastructure market. According to Canalys, China's cloud infrastructure spend in Q2 2021 stood at $6.6B (y/y growth of 56%) [Data Source].

Source: CanalysOver the last several years, Alibaba Cloud's market share has been trending upwards on a global scale, and it is now the 4th largest cloud provider in the world. As digital transformation continues to materialize, China's cloud computing market will proliferate in the 2020s, and Alibaba's leadership position in this market could result in a massive revenue (and free cash flow) stream for the company.

Source: TechCrunchIn addition to retail and cloud computing, Alibaba's strategic investment in Ant Financial is key to its future. Although Ant's attempt at a gigantic IPO (the plan was to raise $34-37B at a ~$300B valuation) failed miserably last year after regulators took actions to block it, Alibaba has used it as an opportunity to increase its stake in Ant Group. With regulators now taking a more sanguine approach, Ant IPO may soon be back on the table, and this time it might just go through. Alibaba has an enviable leadership position in several markets, and if government intervention recedes, this company can go places. The stock is pricing in exorbitant pessimism and fear, and this could be an opportunity for long-term investors to generate life-changing returns. Alibaba's CEO and Chairman - Daniel Zhang - is a fantastic business leader, and anyone interested in owning Alibaba should read his recent shareholder letter to understand where the company is headed.Note: Investing in Alibaba (and, by extension, China) comes with massive risks, which I discussed in the following note: Alibaba: An Opportunity Of A Lifetime Or A Tragic Mistake?. Please understand the risks before making your investment decision.)Concluding Thoughts On BABA StockThe news of Jack Ma's re-appearance and Charlie Munger's firm doubling down on the stock is creating a positive sentiment around Alibaba. With the Chinese government, you never know what regulatory actions may come next; however, the perilous situation developing in China's real estate market means that the government might need to let the tech giants off the hook, at least for now. And so, Alibaba's rebound may continue over the coming weeks and months.Today, Alibaba serves more than 1.18B consumers (annually) with the company's offerings embedded tightly in their daily lives. The Chinese government can choose to punish its golden goose; however, Alibaba may prove to be an unstoppable force over coming years. President Xi Jinping's "common prosperity" goals will undoubtedly lead to near-term pain for wealthy individuals and corporations, but a larger middle-class population will lead to greater consumption in the economy. With digital economies set to proliferate over the coming decade, Alibaba is very likely to remain a critical infrastructure provider that empowers billions of consumers across the globe (primarily in the Asia-Pacific region).Recent government actions suggest that China's autocratic leadership values central power more than the country's economic progress. I understand that investing in China is risky due to its government's evident unfriendliness for investors (bond and equity); however, Alibaba is a cash printing machine that offers an excellent risk/reward here. The maximum we can lose by investing in Alibaba today is ~$170 per share (real loss potential is much lower); however, the gains could be much, much higher than the max loss. At Beating The Market, we have avoided buying Chinese equities since our marketplace's inception in May-2020 due to too many unknown risks associated with China.Although I won't be buying into Alibaba (or any other Chinese stocks) anytime soon, I think it is a good buy at $170 for investors looking for global diversification of their assets and having the risk appetite required for investing in China. We are not deploying capital into Alibaba because we believe there are better opportunities in the US equity markets, and we simply do not need to take on the additional risks of investing in China. For investors considering an investment in Alibaba, Amazon (AMZN) is a great alternative. In short, I like Alibaba at $170 as an analyst; however, I am not buying it myself due to the availability of better capital allocation opportunities.Key Takeaway: I rate Alibaba a buy at $170Thanks for reading, and happy investing! Please share your thoughts, questions, and/or concerns in the comments section below.At Beating The Market, we focus on making lives meaningfully better through investing. To join a rapidly growing community of like-minded, long-term growth investors --> Click Here This article was written by

Ahan Vashi1.51K FollowersFollowAuthor of Beating the MarketWe Focus On Making Lives Meaningfully BetterLong Only, Growth At A Reasonable Price, Long-Term Horizon, Research AnalystContributor Since 2020Ahan Vashi is the lead equity research associate at L.A. Stevens Investment LLC's Seeking Alpha Marketplace service - Beating The Market. He is a "Quantamental" investor who specializes in identifying market-beating stocks by capitalizing momentum of business fundamentals. Some of his top picks include Upstart at $58, Palantir at $9, and Asana at $22.Prior to joining L.A. Stevens Investments, Ahan worked as an Associate Fellow with Jacmel Growth Partners, a middle-market private equity firm where he acquired the art of analyzing financial statements and business valuation. Ahan holds a Master of Quantitative Finance degree from Rutgers Business School and a Bachelor of Technology degree in Electronics and Communication Engineering from NIT, Surat.At Beating The Market, Ahan works with Louis Stevens, Jared Simons, and one of the most vibrant and dynamic investment communities on earth in pursuit of identifying the next Facebook, Amazon, and Salesforce. Beating The Market brings the potent wealth-creating power of Venture Capital to the public markets. For his part on the team, Ahan does this by systematically analyzing hundreds of public companies each year via BTM's rigorously defined set of 23 standards/criteria - BTM's Crucial Characteristics. In addition to high-growth companies, Ahan works on identifying dividend-growth stocks that can deliver supercharged returns with low volatility via massive capital return programs (dividends and buybacks). Most of Ahan's public articles tend to focus on this area, while his research on high-growth companies is available exclusively to members of Beating The Market. If you'd like "Ahan-lite", check out his Twitter profile here: https://twitter.com/VashiAhanIf you have any questions, feel free to reach out to him via a direct message on SA or leave a comment in one of his articles!Disclosure: Ahan Vashi is a promoting contributor for Louis Stevens' SA Marketplace service - Beating The MarketDisclosure: I/we have a beneficial long position in the shares of AMZN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.5 Likes14 CommentsLikeSaveShareComment

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