Alibaba Section 1: Clash of Theses (Part 1)
The craziest Alibaba breakdown (probably because the writer is crazy)
As the title suggests, this is going to be the long-awaited consolidation of my learnings and understanding of this company (Alibaba) which I have a love-hate relationship with. I’m sure by now, you’ve at least heard about Jack Ma, or his darling company Alibaba, at least once in your lifetime, for good or bad. I’ve been monitoring the company on their developments for at least a year now, wouldn’t dare claim to be an expert, but probably have been exposed to enough arguments from both sides of the aisle to provide some perspectives that you might or might not have considered before. Just note that I have a vested interest in this company, so my views WILL be biased. You can also catch me on YouTube & Twitter.
In this series of articles, I will attempt to structure it in the most comprehensive way I possibly can. However, I know that readers/viewers come in with a wide variance of understanding & perspectives. I will try my level best to seek the middle ground. I will break this paper into 3 core parts. Part 1, will cover the qualitative aspects of the company – essentially both the bull and bear theses I’ve come across over the year. In part 2, I will dive deeper into the company itself, its history, business model, product offerings, etc. In part 3, we will reach the quantitative aspect of the company and its valuation.
No promises by the way, because I still have got quite a lot of things on my plate, but I’ll try my best. At least for now, this is the structure I have in mind.
I will further sub-divide Part 1 into 3 separate sub-sections because I realize that the number of Bear arguments is simply overwhelming. Do subscribe if you want to stay up to date!
Introduction
Alibaba Group Holding Ltd – ADR ($BABA – $230Billion in Market Capitalization) is also con-currently listed on the HKSE (Hong Kong Exchange) under the ticker symbol (HKG: 09988). A dual listing arrangement allows Alibaba to improve its share liquidity and enables them to diversify its capital-raising activities, rather than being reliant only on its domestic market. However, it can also be argued that listing on the HKEX is not exactly domestic – because China still has its local Exchanges (mainly Shanghai and Shenzhen), while HK is a special administrative region of China.
For readers who are under the impression that just because Alibaba is one of the ‘crown jewels’ of China, and ought to have special treatment in their local markets, you will be surprised how treacherous the initial journey was for both Jack Ma and Alibaba – which was nicely summed up in this documentary by one of Alibaba’s early lieutenants. So no, China have been rather unkind to Jack and his baby at the start. Furthermore, no one believed in Jack Ma’s vision in creating an internet empire, but thankfully Masayoshi Son (CEO of Softbank) saw the sparkle in his eyes, and decided to take a flyer on Alibaba, turning a $20 million investment in 2000, to $57.5 billion today (even after the 71% drawdown).
If you were to study the current ownership structure of Alibaba; you will be surprised to see that even the locals do not have much skin in the game – which would be addressed in one of the most common bear arguments later.
As you can observe, the percentage of institutional ownership in the company only sits at 35%, while the public holds a rather significant stake of the total shares outstanding. This could be one of the factors that explains the volatility and variances of the stock price movement. If I were to contrast institutional ownership between Alibaba vs. the FAANG names in America, you can better visualize the disparity.
Now, after understanding the nature and characteristics of the shareholding structure of Alibaba, we shall start diving into the qualitative aspects of both the bull and bear arguments around the company.
I believe many new investors were intrigued by this company, right after Jack’s notorious speech on 24 Oct 2020, criticizing the traditional banks for operating with a ‘pawn shop’ mentality, and regulators of having a backward ideology, likening the current banking regulations as a treatment for Alzheimer’s. Right after the speech, Alibaba’s FinTech arm (Ant Financial) IPO was pulled at the eleventh hour, and everything else was history.
And OH, Jack Ma was laying low for a period, and rumors such as him getting arrested or assassinated were spreading like wildfire. For the record, none of it was true because Jack Ma resurfaced again recently, or was it his doppelganger? Hmmm….
Now, let’s try to dissect the few key bear theses that have been floating on the Internet since the start of the crackdown.
China practices Communism
I don’t trust anything that comes out of China
If that’s the premise/assumption that you are operating with, then please do me and yourself a favor, don’t go close to any stocks that are in developing / less-developed countries; because you are going to make the same arguments again and again – no rule of law, corruption, lousy governance… Oh wait, USA also has it’s fair share of fraudulent companies and distasteful scams. Still remember the time where we had Big 5 Auditing Firms; Deloitte, EY, KPMG, PwC, and Arthur Anderson? Oh, AA was gone because of Enron. Who knows whether will we end up with Big 3 instead?
Don’t get me wrong, it’s good to have a healthy level of skepticism, but when brought to an extreme, you’re just going to be cynical and be closed off to all ideas without bothering to understand and empathize. My main point is, China doesn’t have a monopoly over fraud, don’t go down that slippery slope.
On the topic of Communism, it’s a very politically charged discussion. To keep it short, I think it’s probably a mix of Socialism and Capitalism and Meritocracy, but clearly far from being democratic. Personally, I judge based on results rather than narrative. People twist and turn words and rhetoric to suit their agenda, while numbers and growth don’t lie. Whatever system that the Chinese practice is clearly working, based on the infrastructure, developments, people’s employment, and expectations for the future. While on the other side of the globe, you see many countries practicing “so-called democracy” but still have their state affairs in a mess. Let’s not comment too much on politics, but I believe there is no one-size-fits-all, but rather, a style of governance that suits the country and culture.
Take my own country, for example, Singapore. Do you call us a democracy? We do have ‘free and fair elections’, but we were excluded from the US Summit for Democracy. Does our government practice capitalism? Sure, to a certain degree, we have a very prudent and pragmatic government that enacted public housing policies, with a relatively low-cost healthcare system (that is probably close to world-class) and a forced savings system for retirement. Don’t just throw words out so haphazardly when these terms are so charged. And don’t give me the argument that just because Communist is in the name, that’s why they practice Communism. There are many parties worldwide that has the word Democratic in it, but in my humble opinion, they are far from being democratic. It doesn’t mean jack. Please be more critical in your assessments.
VIE Structure- You DON’T Own Anything
The government can take everything away from you
I’m not too sure why this topic suddenly gain so much traction again recently, and it’s not as if they JUST enacted the VIE arrangement onto existing share structures. It has been there since Day 1, and you should be aware of those risks because it was clearly stated in the company’s Form F-1; and the term ‘variable interest entities’ was being mentioned 99 times, not too sure how any sane person can miss it.
I’ll give it to you straight, this is a tail-end risk that cannot be absolved. If you’re uncomfortable with this idea, I can understand. However, I think more from an incentive/intention viewpoint. Why would they (CCP) want to do that? The only logical conclusion I can come up for something like that to happen – this is one of the last moves to leverage against unfriendly forces. If this scenario were to really play out, I think we have more worrying things to think about. Let’s also not forget about the severe ramifications that will accompany the decision to invalidate the entire VIE, on the trust, reputation, and their entire capital market infrastructure.
On a lighter note, rather than listen to random people on the Internet (even famous ones) talking sh*t about the VIE, you should head over to this article from KraneShares where they talked to a Top Hong Kong Private Equity Lawyer who has real, ground experience in dealing with this. I just wanted to quote Marcia on her professional experience “Over the 20 years that the structure existed, the regulators went back and forth on approving the VIE structure… The big turning point was the Foreign Investment Law. When a draft of the law came out, it contained anti-VIE provisions… when the actual provisions come out, those anti-VIE provisions were gone.”
If you allow me to reiterate, I don’t think markets were at all concerned about VIE in the first place, if it was a tail-end risk in any of Wall Street’s consideration/models, Alibaba would NEVER have visited over $300 in October of 2020, because it’s something that cannot be diversified away. It’s just another talking point to accentuate the “risks” of investing in Chinese equity, and it’s a cheap shot.
On the idea of the government taking everything away – Investors usually cite the recent EdTech crackdown and how they destroyed 90% of shareholders’ value overnight. This has nothing to do with VIE by the way. TAL, New Oriental, and Gaotu Techedu did not lose their value because their “VIE was invalidated” – don’t just mash concepts together.
They were destroyed because the government converted a huge part of their profit-generating activities into non-profit and restricted their scope of business. Nothing to do with VIE. Similarly, the government can convert BigTech companies to non-profits as well, I’m not going to deny that fact, but I will expound on my thoughts on why I think it’s unlikely in Bear number 4; specifically about regulations on BigTech. For the exorcism on the EdTech industry, I don’t agree with how they executed it, but I can understand their rationale and perspective. For people that need some perspective on how crazy it is, I think VICE did a decent job, although it might be a limited scope, it allows you to peer into their current lifestyle.
CCP HATES Jack Ma
Xi has a personal vendetta against Ma
This was a very common conclusion many investors get to, just because of the ‘fury speech’ that Jack gave in the latter part of 2020, and we know the barrage of regulatory actions that were raining down on his company. It’s easy to attribute the crackdown on Tech to Jack Ma, because the timing of how things evolved just seemed too perfect, but fundamentally, I think the crackdown on BigTech was overdue. We will talk more in Bear number 4. Particularly for the relationship between Jack Ma and Chairman Xi, I don’t want to comment too much, because it’s probably out of my depth, but I do see A LOT of conspiracy theories online on how they have a personal feud that was unsettled and how Jack was closer to the political faction of previous Chair, Jiang Zemin. I’m not going to tell you what’s the truth (because I don’t know), if you’re interested in this rabbit hole, feel free to dig deeper, but I would just like to comment that this is not the first year Xi and his comrades are in power. If Jack/Alibaba was really a threat, they would’ve been gone. Xi is already running for his 3rd term. 10 years and counting.
For people who think that they wanted to crack down on BigTech because they are getting too rich/powerful, I’ll implore you to look again because the concept of ‘Power’ and ‘Wealth’ in China are 2 completely different concepts. Don’t bring your preconceived notion of Corporate America to China. You’ll be surprised how well-respected those people in Power are, and I can safely make the conclusion that their power is the least affected by these businesspeople. By political infighting, maybe, but not because of Jack Ma or Pony Ma, be rest assured.
For the argument on Chairman Xi having a personal vendetta against Jack Ma to hold true, it has to come through in the actions taken against him as an individual or his company. However, after the 15 months ordeal, it seems like regulations and restrictions hit the entire BigTech industry as a whole, sure Alibaba definitely got slapped with one of the biggest fines, amounting to 2.8B, but Tencent had their fair share too. Meituan not only got fined because of anti-trust but had their business looked into because they were under-insuring their employees. I think you get my point.
At least, it doesn’t seem like a targeted approach to me, no one was spared. Did Alibaba had a harsher treatment because of Jack Ma’s speech? Your guess is as good as mine, but to then jump to the conclusion that Jack Ma was the sole perpetrator of this crackdown and he was being lynched for his actions, I think this argument is a little far-fetched. You might want to join the upcoming season for high jump (since you’re that good at jumping to conclusions).
Bear 4: Regulations are going to DESTROY BigTech in China
Bear 5: The China Economy is CRUMBLING, their policies are all down-the-drain (esp. Covid & Property)
Bear 6: Geopolitical tensions are going to impair shareholders’ value (Delisting, Sanctioning, etc)
Bear 7: If it’s so CHEAP, why are ‘Smart Money’ not buying?
Bear 8: Alibaba’s Growth dropped to a (69-year) low - It’s a Value Trap
Bear 9: Alibaba’s margins have been plummeting like Luna, it’s a sign of an eroding MOAT
Bear 10: Alibaba is feeling the heat, competition will DESTROY Alibaba
If you’re interested in the subsequent discussions around Bear Thesis 4 to 10, remember to stay subscribed!
Happy to hear your thoughts. You can also catch me on YouTube & Twitter as well.
Love,
Chi Keng
Thanks for sharing your insights, I believe it's valuable for BABA and Chinese Big Tech shareholders... but hopefully you won't get traction too quickly, otherwise I'll have to pay you soon 😂
I think Bear 5 is utter bullshit: Chinese economy did astonishingly* well in the last decades and has no good reason to stop doing so. It would even be a strong reason to be bullish to me.
Bear 7 seems to be a bull as well, since some well-known value investors (e.g. Charlie Munger, Li Lu, Mohnish Pabrai) are actually buying Chinese Big Tech, although sometimes dishing out Alibaba specifically for various reasons. Regarding the more "standard" investors, Benjamin Graham and Peter Lynch summarized it well, they have more to lose by making bold moves such as buying Chinese Big Tech than to earn from it. They have to copy each other to some extent to not be blamed later on if things turn crap.
Thus, I would be more interested into:
-what could be the incentives of the Chinese government leading to stop foreign investments and wipe us all out? Hopefully it will be partly covered in Bear 4 & 6; I fail to assess this risk
-what could make Alibaba business less profitable (Bear 9 & 10, maybe 8 too - I didn't get the title)
Thanks for keeping the good work! Can't wait to see your next thoughts.
*for context, especially to any Occidental readers here, we tend to mock China as the nation making our "made in China" clothes and machines, exploiting children, submitted to a dictatorship, made of similar looking people just good at working hard at school while keeping a low profile people, etc. A bunch of clichés that lead Western people to seriously underestimate this incredible nation. We know they are doing better than before but really don't realize to which extent. Personally, I would have totally missed it if I had not done a short analysis of the countries that have done the best in the last 30-40 years. It's almost as if the whole nation got the purchasing power of a CEO. Most would sacrifice a bit of freedom to be multi-millionnaires, so let's be more low-key regarding our judgment towards this country...