Overview Q3 and thesis
Ali Baba (New York stock market :BABA) is program to publish its third quarter results on 11/17/2022. Its second quarter results (released on August 4, 2022) surprised the market from afar. Its Q2 EPS came in at $1.40, beating consensus estimates of $0.57. However, there are many factors for Q3 which may worry investors. First, the COVID situation is still ongoing. The Chinese authorities would accelerate the Zero COVID case policy by imposing new lockdowns. Second, the company also faces significant domestic political uncertainties. President Xi was elected for a new term of 5 years. And the market reaction since then seems to perceive that the regulatory and government crackdown on Chinese tech companies like BABA will continue for years to come. Finally, I would also be attentive to management’s comments regarding the impact of international geopolitical tensions on its operations, such as those of the current situation between Russia and Ukraine and trade tensions between the United States and China.
In total, market consensus estimates call for Q3 EPS of $2.43, a 73% increase QoQ. While such a consensus estimate represents a far cry from its EPS of $11.2 in Q3 2021. Such large swings (both QoQ and YoY) reflect the huge uncertainties currently surrounding its earnings.
Hopefully, the thesis here will help ease your anxiety a bit by diverting your attention from its earnings. As this article continues, you’ll see that regardless of what happens to its third-quarter earnings (which are subject to great uncertainty), its existing assets (which are much more certain) already exceed its market capitalization.
BABA’s main assets
The chart below shows the Assets section of its balance sheet published on June 30, 2022. As seen, it reported total assets of $255.05 billion. And the main assets of BABA consisted of the following:
- $96.29 billion in current assets (composed primarily of $67.65 billion in cash and cash equivalents in short-term investments and $21.27 billion in receivables)
- $26.55 billion in net property, plant and equipment
- $66.69 from various equity investments (such as Ant Group)
These three alone already total $189.4 billion, already above its current market cap of $178.1 billion at the time of this writing and more on that later. Let’s look first at the liability side of the balance sheet.
The next graph below shows liabilities and total equity, again as shown on June 30, 2022. As seen, its total liabilities were approximately $91.37 billion. Considering its total assets of $255.05 billion, as mentioned above, its total capital was around $162.29 billion.
As a result, the top three items I listed above (with a total of $189.4 billion) are a bit above its total capital (by about 16%). We’ll keep that number in mind as we move forward.
BABA: an asset valuation approach
The following chart shows a simple sum of the parts (“SOTP”) analysis based on the information above. Note that this analysis was performed on the basis of a diluted number of shares of 22.038 billion shares, as indicated during the June 30, 2022 filing. And note that each ADS represents 8 ordinary shares.
Some highlights of SOTP analysis in particular:
- Currently, more than 54% of its market capitalization is just current assets ($96.29 billion out of $178.1 billion), the asset with the least uncertainty.
- Nearly 69% of its current market cap is current assets/cash plus its net PPE (property, plant, equipment), the second most certain asset in my mind.
- And finally, if we add its equity investments, these three parts would be worth around $189.4 billion, or $70.88 per ADS.
Compared to its current market capitalization of $178.1 (or share price of $66.6 equivalently), these three elements alone are already 6.4% above its market price.
Of course, as mentioned above, these three items exceeded its total equity by about 16% as mentioned above due to its liabilities. So the margin of safety (“MOS”) here is a bit narrower than 6.4%. But given that this is an asset pricing approach and we ignore its full profit potential, I think the uncertainties of the current MOS are a secondary issue. To put that into perspective, I expect it to generate around $26 billion in free cash flow this year, easily outpacing the gap between those three major parts and its total capital.
Risks and Final Thoughts
In addition to all the risks mentioned above, a large uncertainty in my valuation of the assets above involves the valuation of the Ant Group. And the valuation of BABA’s assets can vary greatly depending on the price you want to put on his Ant group. Ant was considered the world’s most valuable private company in 2018 with an expected IPO worth around $315 billion. After the failed IPO and regulatory changes, its valuation dropped significantly but still remained above $200 billion according to estimates by Warburg Pincus LLC. More recently, according to the following Reuters report in June 2022, a relaunch of Ant Group’s IPO appears to be a realistic possibility. The following details are taken from this report and slightly edited by me:
Chinese billionaire Jack Ma is considering ceding control of Ant Group… after a regulatory crackdown that scuppered its $37 billion IPO in 2020 and led to a forced restructuring of the fintech giant. Ant informed regulators of Ma’s intention as it prepares to restructure into a financial holding company, according to the report, adding that regulators did not require the change but gave their blessing.
To add further uncertainties to Ant’s valuation, the timing of its IPO relaunch also remains uncertain. According to the following Bloomberg report (also from June 2022 and also slightly edited by me):
Ant Group is set to apply for a key financial license as early as this month, people familiar with the matter say, a sign that its lengthy overhaul following a crashed listing in 2020 is moving closer to satisfying Chinese financial regulators. The People’s Bank of China intends to accept Ant’s application to become a financial holding company once it is submitted and will then begin a review process, which could take months, the people said. , asking not to be identified discussing a private matter. Officials will review Ant’s capital strength and business plans, as well as compliance from its shareholders and senior management before final approval.
All in all, despite the above uncertainties surrounding Ant Group’s valuation, my thesis is that its current market valuation is quite close to its 3 main assets analyzed in this article (plus or minus 10%). In particular, more than 54% of its market capitalization is made up solely of current assets (cash and cash equivalents), the asset element with the least uncertainty. And nearly 69% of its current market capitalization is cash plus its net PPE, the second most certain asset in my mind. Whatever the uncertainties related to the valuation of Ant Group, they are limited to the remaining 31%. Hopefully, given that most of its current valuation can only be supported by its assets, this analysis helps ease your anxiety a bit by diverting your attention from the big uncertainties surrounding its third-quarter earnings.
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