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Thesis Summary

China has been the subject of much controversy in recent news; fraud, coronavirus, and a hostile attitude towards other countries just to name a few. This has led many investors to shun Chinese equities, providing less emotional investors with some great value opportunities.

Alibaba Group Holdings Limited (BABA) continues to stand out as an incredible company trading much below its fair value. The stock is also a great way to diversify your portfolio and hedge amidst geopolitical uncertainty.

From China, With(out) Love

We are long BABA and remain “optimistic” on China, but there are certainly some questionable things going on within the borders.

Firstly, there is the Luckin Coffee Inc. (NASDAQ:LK) scandal; a company that engages in the sale and delivery of brewed drinks and pre-made food. LK made headlines when its headquarters were raided by Chinese regulators. The firm’s shares slumped after it revealed that it had uncovered $310m (£250m) in fake transactions; about 40% of the estimated annual sales. This has of course put a dark cloud over China and many of the companies based there trying to sell shares and obtain financing abroad.

On other news, animosity continues to brew as Europe and the U.S. blame Beijing for the coronavirus outbreak. Not only is China being blamed for failing to contain the outbreak, but many countries are now starting to believe that China may have deliberately misinformed the rest of the world regarding the number of deaths and cases. Angela Merkel recently urged China to be more “transparent”.

The coup de grace, comes with the allegations that China has sold faulty medical equipment to Europe. I have witnessed this first hand and know for a fact it is true. There have been, as far as I know, not one but two faulty batches of COVID tests sent to Spain, where I live.

With all this, Beijing seems to have been far from apologetic to outsiders. If anything, it seems China is taking this as an opportunity to gain power and influence. I will in no way deny that China is a “threat” to the Western world. For years now the country has been increasing its influence across the globe. Even NATO is now showing concerns over the increasing presence of Chinese companies in Western infrastructures and supply chains.

Now, BABA is also in the crosshairs, with the Senate recently passing a bill that could potentially delist Alibaba and other Chinese companies. This was of course discussed in the latest conference call, with CFO Maggie Wu stating they are working to comply with regulations both in China and the U.S. which at times contradict one another.

The bottom line is, Alibaba is not China, and while tensions may keep growing between the countries, I believe sound business decisions will ultimately outweigh politics. Delisting BABA or reporting false figures is in no one’s long-term interest.

BABA: King of Value and Growth

Chinese equities have been hit by the black cloud that is hanging over the country. This has created some value investing opportunities and no Chinese company offers a better opportunity than BABA.

Cloud, continues to be the company’s biggest growth motor, with the segment increasing over 60% in the last year. Given that the company has recently committed to investing over $20 billion in the coming years, I expect this growth to continue.

Furthermore, Alibaba continues to revolutionize all areas of life in China, including digital payments. The company has confirmed that, through Alipay, it will be helping to launch the Central Bank’s new digital currency. This comes at a time where concerns of pathogens like COVID spreading through physical money will only help push countries towards complete cashlessness.

Since we made our DCF valuation, BABA has reported another quarter and its full-year report, so we can now see how these latest numbers affect our forecast.

Below we can see a simplified balance sheet, income statement, and some growth ratios for the forecasted period as well as a target price/return based on the discount you apply. The B/S and Income statement that is shown here is for the next 10 (2021-2030) years but the forecasted period and target price/return is reached through a full forecast ending in 2050.

Source: Author’s work

As we can see above, we have forecasted revenue growth to slowly decrease but continue in the double-digits for the next 10 years. We do however expect gross margin to slowly decrease as the company achieves diminishing returns of scale. While revenue increases, need for funding operations improves (negotiation power etc.) so the net assets go negative. As revenue growth slows, so does return on assets and the net operating assets become positive again. Other costs such as R&D and SG&A have increasing returns to scale, so their % goes down over time, but they are relatively small. Lastly, as far as financial risk goes, the company is about as strong as it gets.

Investing is a game best played with the head rather than the heart. An objective and pragmatic approach leads to the conclusion that BABA is an outstanding investment. Given the current price the implied return is near 13% which is far above what we have estimated for other big players such as Alphabet (GOOG) (NASDAQ:GOOGL) and Facebook (FB). You can read more about them here and here.

Investing in BABA means investing in eCommerce, cloud, digitalization but also China. Whether you like it or not, this is where money and growth will be coming from in the next 10 years. While BABA may face some political challenges, we believe the company is committed to maintaining its international position and as time goes by more and more investors will realize everything that this giant has to offer.

Disclosure: I am/we are long BABA. 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.

This content was originally published here.