Charlie Munger (Trades, Portfolio)’s Daily Journal Corp. (DJCO, Financial) owns four stocks, collectively valued at more than $160 million according to 13F filings. Chinese e-commerce giant Alibaba Group Holding Ltd. (BABA, Financial) is one of them, taking up 19% of the equity portfolio.
Munger has historically only had positive things to say about Alibaba. However, he has recently changed his tune. While it is no secret that the investor likes China, at the Daily Journal’s annual meeting in February, he called it “one of the worst mistakes I ever made.”
“I never stopped to think [Alibaba] was still a retailer," Munger said, "It’s going to be a competitive business.”
Here’s where Munger needs to be patient as a long-term investor and remember that the company is not a retailer. Rather, it is a data-driven conglomerate with omni-channel retail, cloud computing, media and entertainment and online-to-offline services. Its flagship website is a wholesaler distributing products mostly in large quantities. It allows goods from Chinese manufacturers to be bought in bulk at a discount and sold to consumers via a number of different avenues. For instance, if you search Amazon, you will find there are a lot products from Alibaba on there. It is a very symbiotic relationship.
Alibaba's services have more than 1 billion active users according to QuestMobile. For comparison, China's total population is 1.4 billion. This massive user base provides the company with an unmatched reservoir of data. This data can be harnessed to assist merchants and consumer brands in crafting personalized marketing and content strategies on mobile platforms. Such targeted strategies can aid in reaching a wider audience, enhancing click-through rates and in-store transactions, and significantly improve the return on investment. In other words, it is not just a retailer.
Recent challenges and regulations
Alibaba has faced several challenges in recent years, including regulatory scrutiny and changes in its business structure. In November 2020, Chinese regulators released a draft that gave authorities a wider latitude to regulate their biggest tech enterprises, which affected Alibaba and its affiliate Ant Group. It is best known for operating Alipay, one of China's most popular mobile payment systems. The government then launched an antitrust investigation into Alibaba over monopolistic practices, causing a significant drop in its stock price.
In 2021, Alibaba was fined $2.8 billion for anti-competitive practices by China's State Administration for Market Regulation as part of a crackdown on big tech​. Despite these challenges, the company reported a 14% increase in orders during its 11-day Singles Day sales extravaganza in November of that year.
In 2022, the SEC added Alibaba to a list of companies facing delisting from U.S. stock exchanges if its auditors remained unable to examine its books before 2024. These challenges did not have a positive impact on the stock and only highlighted the dichotomy of the Chinese economy.
Then in March of this year, Alibaba announced a major restructuring, transforming into a holding company and separating its subsidiaries into six independent entities. These entities include the Cloud Intelligence Group (cloud solutions), Taobao Tmall Commerce Group (local online commerce services), Local Services Group (delivery services), Cainiao Smart Logistics Group (logistics), Global Digital Commerce Group (AliExpress, and Digital Media and Entertainment Group (gaming, motion pictures and web services)​.
The company is is preparing to spin off its cloud business as well, creating a leading pure-play opportunity for investors, which could lead to more spinoffs in the future.
A word of caution
Under Chinese law, it is illegal for foreigners to have full ownership of certain Chinese companies. It makes perfect sense and I totally get it. However, almost every listed Chinese company investors can buy outside of China is through a structure called variable interest entity. It is like a derivative contract with zero real ownership in the actual company.
Here’s how it works. A company like Alibaba sets up a company in the Cayman Islands that can be owned by anyone. This company enters into a series of contracts with the local Chinese company, giving it certain carefully curated economic interests and control rights over the Chinese company, not real ownership. Then you list the company on the Nasdaq or New York Stock Exchange and people buy its stock, most not knowing they have no rights at all in the actual company. The company is more or less an empty shell with a loose contract.
Of course, the fairy dust could be worth more and more as the company grows. Even in the United States, owning public equities does not mean much unless you have a controlling interest. China would likely never allow anyone that level of control. With that in mind, there are more than 240 Chinese companies listed on U.S. exchanges with a total market cap exceeding $2 trillion. Most of these companies are tied to contracts held in shell companies in the Cayman Islands.
Under Chinese law, the VIE structure occupies a gray area. It is not officially recognized by the government, but it also has not been declared explicitly illegal. This is more of a workaround than a real problem for now.
Flat since IPO equals opportunity
With all that in mind, Alibaba remains undervalued even while trading with a market capitalization of $217 billion. Since going public in 2014, the company has increased retained earnings by $85 billion. By October 2020, Alibaba had surpassed $835 billion in value; however, shares are sitting right around the initial public offering price again currently.
Alibaba's Cloud Intelligence Group will be spun off through a stock dividend to investors at some point over the next 12 months. That will likely return around $31 billion, most of which may already be priced into the current market price.
Nearly 20% of all retail purchases are expected to take place online in 2023, with total retail spending in the first quarter alone north of $1.8 trillion. This is excellent news for platforms like Alibaba. More importantly, retail spending needs to be directed more online for the company to grow. At this point, I think that is nearly impossible to slow down, let alone stop, so it is only a matter of time before the stock returns to its higher market valuation.
