Alibaba Q3: Big-Short Michael Burry's Long Position

Thesis

Michael Burry is best known as the "Big Short" because of his successful bet against the U.S. housing market in the mid-2000s. Burry was one of the first investors to recognize the growing subprime mortgage crisis. He decided to short the market by purchasing credit default swaps on these securities. His bets turned out to be prescient and made huge profits for himself and his investors.

His latest 13F filing shows that he had established a sizable long position on Alibaba Group (NYSE:BABA) as shown in the chart below. To wit, during Q4 2022, his Scion Asset Management accumulated a total of 50,000 BABA shares at around a price of ~$88. His BABA position is now the 4^th largest position in his portfolio, representing about 9.5% of his total asset.

In the meantime, BABA is scheduled to release its earnings report (“ER”) on 02/23/2023 before the market opens. The ER will be for its fiscal Quarter ending Dec 2022. With the volatilities historically observed during the ER, I anticipate the stock prices to fluctuate in a wide range and could revisit the $88 level again.

And in the remainder of this article, I will explain why I share Burry’s view and see these levels as attractive entry points for BABA.

BABA: near-term headwinds dissipating and long-term growth intact

BABA financials faced strong headwinds in the past 1 or 2 years. Take its last quarter’s results as an example. Revenues dialed in at $29.1 billion, translating into a contraction of 6% on an annual basis. The lackluster results were due to a range of factors: elevated operating costs, a slowing economy, and consumer demand due to the resurgence of COVID-19 restrictions, and also the ongoing regulatory pressure from the Chinese government on its tech firms.

However, I see these headwinds to be near-term and also see signs that they are dissipating as we speak. I see signs that the Chinese regulatory authorities and its major technology companies are beginning to ease their tensions. Despite the authorities' tough stance on Chinese tech firms in recent years, the struggling domestic economy appears to be prompting a warming trend, largely to stimulate the country’s economic growth. For instance, Ant Group (of which Alibaba owns roughly a third of the fintech company) has been granted the green light to proceed with its plans to raise $1.5 billion in capital for expanding its consumer business. Additionally, the COVID-related restrictions have been mostly lifted lately.

For the long term, thanks to its robust organic cash flow, BABA enjoys superb capital allocation flexibility and invests aggressively in future growth. To wit, its CAPEX expenditures totaled $6.5B in the last quarter, the highest level in recent years. Its profitability is no longer as astronomical as it used to be as seen in the second chart below. However, as measured by its return on capital employed (ROCE, detailed in our earlier writings), it is still hugely profitable. Its ROCE now hovers around 64%, still above the average level of the FAAMG group (around 40% to 50%). In our investment experiences over the past 2 decades, the combination of capital allocation flexibility and high ROCE has been the proven recipe for sustainable long-term growth.

The $85~$115 accumulation range

Yet, the stock's valuation appears to be heavily compressed, as evidenced by the two charts provided below. The first chart shows that the stock is currently trading at a price-to-cashflow ratio (“P/OPC” ratio) of 10.9x only, which is near a historic low over the past 5 years. Similarly, the second chart shows that the stock is trading at a compressed valuation in terms of EV/EBITDA multiples too.

As aforementioned, volatilities historically observed during its recent earning report, the stock could fluctuate in a wide range and revisit the ~$85 level. And as seen, at $85, its EV/EBITDA multiple would be only 8.24x and its P/CFO multiple would only be 10.4x. Even if the ER triggers a price surge to $115, its recent peak level, the EV/EBITDA multiple would be 10.8x and the P/CFO ratio 14x, still very attractive levels given the profitability and growth potential of the stock as you can see from the 3^rd chart below. To wit, consensus estimates foresee an EPS growth in the double-digit (11% CAGR) in the next five years. As a result, its FW P/E would shrink to 10.7x next year and fall into the single-digit range after that. As a result, the PEG ratio (P/E to grow ratio) would fall below the 1x threshold for buying growth at a very reasonable price.

Risks and final thoughts

In the longer term, some of the key risks that Alibaba faces include regulatory risks and competition risks. As aforementioned, Alibaba is subject to regulations set by the Chinese government. Any regulatory changes, such as stricter data privacy laws or restrictions on e-commerce activities, could adversely impact the company's business operations. I am seeing signs of these risks dissipating as argued earlier. However, such risks always exist (they exist for the FAAMG stocks in the U.S. too). Also, many areas Alibaba operates in are highly competitive markets, such as e-commerce, cloud computing, and digital payments. Competition from existing players, as well as new entrants, could potentially reduce Alibaba's market share and impact its revenue growth.

To conclude, I share Michael Burry’s view on BABA and could see why BABA is attractive at its current price levels. Looking ahead, the signs of relaxing regulatory restrictions is encouraging. Moreover, the COVID-19-related headwinds should start to abate and support healthier economic growth and improved consumer spending. As mentioned, the upcoming earnings report itself represents a near-term risk, which could large price changes in either direction. And potential investors could take advantage of the volatility in case it causes the stock price to revisit the lower end of the accumulation range.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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