We continue to be bullish on Alibaba (NYSE:BABA). We expect China’s rapid reversal of its COVID restrictions to drive Alibaba’s stock further as the company’s main geographic source of revenue, China Commerce, recovers. We believe Alibaba is a Chinese stock that provides an attractive profile amid the tightening and volatile macro environment in the rest of the world.

Since we first published our buy rating on Alibaba in late November, the stock rallied 36% to date. We recommend investors ride the upward trend while the stock’s valuation is attractive. We see Alibaba outperforming toward 2H23 as China’s reopening serves as a key growth catalyst for Chinese stocks, and Alibaba is no exception.

The following graph outlines our rating history on BABA.

Bull market for Chinese stocks materializing

We believe Asian-Pacific stocks are entering a bull market fueled by China’s rapid reopening, and expect Alibaba stock to continue to rally in response. In our previous note on Alibaba, our thesis was centered around Alibaba cloud and diversified revenue sources abroad. We now add another layer to our bullish sentiment: China’s efforts to rapidly exit the lockdown environment.

Bloomberg Economics expects China’s abrupt reversal of its COVID policy to pave the way to a full reopening by mid-2023. We expect China’s reopening to be a growth driver for Alibaba, as the company derives 65% of its total revenue from its China Commerce segment. In 2Q23, the company reported a 1% Y/Y decline in its China Commerce revenue. We believe China’s reopening and Chinese New Year festivities will boost revenue growth and fuel Alibaba’s recovery. We believe Alibaba and others in the e-commerce space, including JD.com (JD), will see demand tailwinds in 1H23. According to Pattern research, during the Chinese New Year, Chinese retail and e-commerce companies’ historical sales rose for “more than a decade until the COVID-19 pandemic struck in 2020.” We believe Chinese stocks will experience a rebound in sales this Chinese New Year as China’s economic slowdown becomes history. Sales of the Lunar New Year specialty, nianhuo, already surged 30% Y/Y on the company’s online retail platforms, Tmall and Taobao marketplace, in the first two weeks of January. Part of our bullish sentiment on Alibaba is based on our belief that domestic consumption will help revive the company’s revenue growth in 1H23.

Asian-Pacific’s leading index, the MSCI Asia Pacific index, already rose 7.2% this year as of February 9th, after declining 20% in 2022. In mid-January, the MSCI Asia Pacific Index grew nearly 21% from its 52-week low in October, according to data from Refinitiv. We believe this is a forward indicator that Chinese stocks are gradually entering a bull market, and we recommend investors buy Alibaba as an entry point into Chinese stocks.

We also believe Alibaba’s effort to launch a rival to ChatGPT is a good sign that the company’s headed in the right direction for long-term growth. The company will be among the latest in the tech space to join the chatbot bandwagon. We believe Alibaba has a long way to go before competing meaningfully with OpenAI’s ChatGPT or Alphabet’s (GOOG) new “Bard” tool. Still, we believe Alibaba working internally on cutting-edge innovations within the generative AI space has the potential to be a long-term growth driver, as the generative AI market is estimated to grow at a CAGR of 27% between 2023-2032.

Cloud is a slowly but surely long-term growth driver

We like Alibaba’s position in the cloud-computing space and its steps to invest $1B in its Alibaba cloud segment, but we expect the company’s cloud business to face near-term headwinds. We’re constructive on Alibaba’s cloud segment as it competes with the top players in the cloud-computing space, mainly Microsoft’s (MSFT) Azure, Amazon’s (AMZN) AWS, and Alphabet’s Google Cloud. Our concern regarding Alibaba’s cloud segment is not due to any shortcomings from the company, but due to the weaker spending environment resulting from macroeconomic headwinds. We believe inflationary pressures and heightened interest rates have materialized, weaker IT spending from corporate customers. We believe corporations are stingier when allocating budgets during current macroeconomic headwinds, with Canalys reporting that cloud computing’s “annual growth rate fell below 30% for the first time” in 3Q22. We don’t believe Alibaba is immune to the weaker spending environment and expect the company’s cloud business to be pressured in the near term.

The stock rallied after cutting voting power on Ant Group

We believe co-founder of Alibaba, Jack Ma’s decision to lower his stake in Ant Group is another positive growth catalyst. Alibaba stock rose by more than 2% after Ma’s exit from Ant Group on Monday. We believe Ma’s decision to cede control of Ant Group is positive for Alibaba and positions the company for more growth as it slowly ends the Chinese government’s crackdown on tech companies. We believe Ma’s been there for Ant Group’s woes, specifically back in 2020 with the last-minute cancelation of Ant Group’s $37B IPO. The cancelation took place after Ma made some comments about the Chinese regime. We expect Ma’s decision will likely Improve Chinese authorities’ regulations on the tech space and even may suggest that China’s tech crackdown is over.

Valuation & Word on Wall Street

We believe Alibaba’s stock is relatively cheap. Based on Alibaba’s current enterprise value and its revenue TTM ending September 30th, the company’s EV/Revenue is 1.78x, while Amazon’s EV/Revenue is 2.1x. We expect Alibaba to be in an upward trend and recommend investors buy the stock at current levels.

Wall Street shares our bullish sentiment on Alibaba. Of the 47 analysts covering the stock, 41 are buy-rated, four are hold-rated, and the remaining are sell-rated. The stock is currently priced at $103. The median sell-side price target is $146, and the mean is $143, with a potential upside of 39-41%.

The following table outlines the sell-side ratings and price targets for BABA.

What to do with the stock

We’re bullish on Alibaba; we expect the stock to be driven higher as China lifts COVID regulations and moves towards a full reopening by mid-2023. We believe Alibaba is better positioned to grow meaningfully in 2023 as it expands its revenue sources and simultaneously regains revenue growth at home in its China Commerce segment. We also believe the stock is too cheap to ignore, providing a favorable entry point at current levels. The stock is up nearly 42% from its 52-week-low of $60.25. While investors are often hesitant about jumping into Chinese stocks, we believe Alibaba is worth the investment, as we expect Chinese stocks to enter a bull market in 1H23. We recommend investors buy the stock before it rallies further.

Alibaba Group is leveraging its platform power and joining forces with its ecosystem partners to promote carbon neutrality in the consumer industry.

The Hangzhou-based company is developing standards for low-carbon goods to Improve the supply and quality of sustainable products while working with brand partners to increase consumer awareness.

“By leveraging the efforts and resources of the wider community, we have been able to address the consumer sector’s carbon footprint more effectively and innovatively,” said Alibaba’s Chief Marketing Officer Chris Tung at a virtual side event during the United Nations Economic and Social Council’s 2023 Partnership Forum in January.

Alibaba has vowed to slash 1.5 gigatons of carbon emissions across its digital ecosystem by 2035 with its pioneering “Scope 3+” concept that extends beyond its own operations and direct value chains.

Watch how Alibaba partners with leading companies to advocate for low-carbon consumption.

Key Quotes

“We are working with our ecosystem partners to promote decarbonization across the consumer sector,” said Alibaba’s Chris Tung.

“We are committed to reducing these emissions generated across our platforms but outside of our own operations and direct value chains,” said Tung.

Please refer to https://www.alizila.com/esg/ for additional information about Alibaba’s sustainability efforts.

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Alibaba Group

About Alibaba Group
Alibaba Group’s mission is to make it easy to do business anywhere. The company aims to build the future infrastructure of commerce. It envisions that its customers will meet, work and live at Alibaba, and that it will be a good company that lasts for 102 years.

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Michael Burry's fund Scion Capital has just released its 13F filing, showing that the renowned fund, which became notorious for shorting the housing market in 2008, has taken a decent position in Alibaba (NYSE:BABA).

We discuss why we strongly believe Alibaba stock to be a 'buy', the reasoning behind why Michael Burry presumably bought his 50,000 shares in the stock, along with our own valuation model and some unique macroeconomic insights.

As For Me, I Like Hong Kong

Michael Burry alluded to his interest in Chinese stocks not too long ago, in a series of a few tweets. One of those tweets simply said without context:

As for me, I like Hong Kong. (12/04/2022, Twitter)

More importantly, he shared a statement earlier in October when the Hang Seng was heading for new lows around the 15,000 price level, the same levels at which the Hang Seng also traded in 1997. He had the following to say:

Meet the new boss, same as the old boss. The Hang Seng recently hit 1997 levels. 25 years. Yet GDP multiplied 18 times during that time. 1997 valuations were 20x Earnings, 10x EV/Sales, 3x Tangible book. Now 7/1/1. Note, 3 of the last 4 Premiers served 3 terms. (10/25/2022, Twitter)

He also shared the chart below, which clearly shows that the index has not changed much over the past 25 years. However, his statement at the end makes investors wonder what exactly he means by "3 of the last 4 Premiers served 3 terms." We think this mainly refers to the public's overreaction to Xi Jinping's 3rd term that he is now serving, as the last 3 out of 4 Premiers have done the same.

To give some context: Chinese stocks seem dirt cheap. Data on Chinese indices are quite scarce, but the data that can be viewed seem to indicate that China is in a bottoming out process at current price levels.

If we look at the Hang Seng Index, as Michael Burry also pointed out, it typically trades at a P/E ratio of about 14x. And with 1 standard deviation down, it comes down to a valuation of 10x P/E. At the 7x P/E ratio he pointed out, when the index was trading around 15,000, it was trading more than 1 standard deviation below trend. That's similar to where it was trading during its lows in 1999 and 2009.

The lowest valuation we could find in modern history was a P/E ratio of 6.1x in the early 1980s. Currently, the Hang Seng is trading around a P/E ratio of 8.46 or a CAPE ratio of 9.59x (TTM).

Which also ties in perfectly with a tweet he made earlier:

China's markets are having an "America in early 2009" moment. Fear and uncertainty are peaking or close to it But China is too important to America, 20X Russia. America cannot effectively fight or sanction China without spiting itself nearly as severely. Just ask @KingJames (09/21/2022, Twitter)

That last statement may have been directed toward LeBron James and his attitude in the past. So from a historical and relative valuation perspective, it could well be that the bottom has already been reached for China.

If we overlay the indices of the largest markets, presumably the U.S., China and Europe, they have traded relatively evenly in the past. That was mostly until about 2013, when the Hang Seng was consistently cheaper than Europe and the US. We think there is a good chance that this widening divergence will eventually reverse.

As for when Michael Burry bought his shares, the report reflects the shares he owned at the end of the fourth quarter. We can't know exactly what price Dr. Burry paid, but we do know that it was in the range of $63.15 and $94.17.

For simplicity, we take $78.87 because that was the average price range where Alibaba shares traded in Q4 2022.

Just before Michael Burry started his Hedge Fund, he explained his investment strategy and applied it to case studies. In fact, Michael Burry uses Technical Analysis, but mainly for risk management and nothing too crazy.

He stated this on Technical Analysis:

Nothing fancy. But I prefer to buy within 10% to 15% of a 52-week low that has shown itself to offer some price support. That's the contrarian part of me.

This is where it fits perfectly with Alibaba, as it went right back to where it was in 2015/2016, bouncing perfectly off its support around $58. We think there is a chance that Dr. Burry actually bought his shares below $66, or 15% above trend, although it is mostly speculation on our side.

Still, we think the stock becomes a strong buy when it gets into this $66 trading range. This is for valuation reasons we will explain, and because we can buy the stock and set a stop-loss at $58 in case Alibaba breaks through that support level, and limit losses to just over -12%.

Our Valuation Model

Alibaba is perhaps one of the most undervalued companies we believe is currently on the market. Paradoxically, for a company that has seen its revenues grow at an average annual rate of 43.3% between 2013 and 2022, it is only trading at a Forward P/E ratio of 13.47x.

And this analogy can be extended across the board. Alibaba has experienced astronomical growth in terms of EBITDA, with an annual growth rate of 33.8%. Free cash flow has also grown tremendously, from $1.93BN in 2013 to $14.19BN in the past 12 months.

This means that both our measures EV/EBITDA and P/FCF check out. We believe, in this case, that the rewards still far outweigh the risks by trading below 12x FCF or at a relatively normal 17x EV/EBITDA.

That's another reason why it would be a great buy if it gets near those all-time lows. It certainly has the same characteristics as the opportunity to buy Amazon (AMZN) in late 2008, when it also bottomed around a 10x EV/EBITDA multiple and a P/FCF multiple of 15. However, we understand that Alibaba could still bottom at lower levels, as the U.S. has always traded at a certain premium to China.

For us, Alibaba seems right on both an absolute and relative valuation, based on simple measures. Since we are long-term investors, we will look at how we see Alibaba for the future and where it could be in the next 10 years.

First, revenue. Alibaba has experienced monstrous growth of more than 43% over the past 10 years, in the same exponential fashion as Amazon. There are many reasons to believe that this growth could continue for quite some time, although we have modeled our forecast more conservatively.

After all, Amazon has managed to grow its sales by more than 24% over the past decade against all odds, from the same baseline which Alibaba is at right now. We still factored in a lot of headwinds for 2023, close to the Wall Street forecasts, as short-term forecasts tend to be relatively reliable. We also factored in headwinds for EBITDA margins, but expect them to return to healthier levels.

A relative measure is that Alibaba will average an EBITDA margin of 33.8% between 2015 and 2020. We expect Alibaba's cloud, which is still in its infancy at <0.1% of China's GDP, to be a major driver of this growth, providing huge tailwinds in addition to domestic trade revenues, like has been the case for Amazon over the past decade.

This is also in line with the expected CAGR of 12.4% that China will experience, according to market research. From a cash flow perspective, we have also modeled headwinds for 2023. We will explain our reasoning for these headwinds and a lower growth rate in the next section of our valuation. Our cash flow estimates are based on a linear growth rate closer to 12%, compared to the CFO's 33.6% growth rate over the past decade.

In all of our models, we also consider stock-based compensation to provide a true picture of profitability, as stock-based compensation historically appears to be near 10% of revenue.

Capital expenditures were also modeled accordingly and grow linearly with revenues. Our valuation shows an expected EBITDA of $70.66BN and FCFE of $40.74BN by 2032.

So on an EV/EBITDA basis, taking into account cash and debt, we arrive at a market capitalization of about $1.00T around 2032, or $372.77 per share at a 14x multiple. We chose a lower multiple of 14, compared to the average of 16x, to account for the lower valuations in China relative to the US.

On an FCFE basis, as you can see below, we think Alibaba has the potential to generate $15.16 in FCFE/share by 2032. We again chose a fairly high FCFE yield of 6%, taking into account higher interest rates and the China discount rate. We arrive at a price per share of $252.74 on an FCFE basis.

Finally, if we take both valuations together at a 50% weighting, we get our final estimate of $312.76 per share, or roughly a 200% increase over the current share price.

In an IRR calculator, that's a stunning 20.06% IRR over the next 10 years. We can't find many stocks with a higher IRR, frankly.

To us, everything fits: there is a margin of safety on a technical analysis basis and current valuation basis, trading at low multiples. Even if growth were to disappoint, at an EV/EBITDA multiplier of 12x it can be considered an attractive value stock.

In summary, the downside is relatively limited when looking at fundamentals, while the upside potential is absolutely enormous. As for the downside, there are quite a few risks.

The Kitchen Is Heating Up

All that growth and opportunity sounds fantastic. So why do we think Alibaba is not yet a "Strong Buy" at current prices. Well, there are still a lot of daunting risk factors to consider.

And getting back to Michael Burry's notion that GDP has multiplied 18 times while stocks have not really moved, we want to add some caveats. Because China's GDP and growth model can be a bit misleading. In this situation, the stock market may be the smartest one in the room, not GDP.

While China's GDP has grown astronomically, there are reasons to believe that this rise will not last forever. One such reason is China's economic model, which can essentially be described as "growth at any cost." As a result, China's economy has seemingly become more credit-driven in exact history. This came to light for most people with Evergrande in late 2021, which revealed the unhealthy and unsustainable growth of China's real estate market.

And we have all seen what a credit-driven frenzy can look like, just look at Japan in 1989. Funnily enough, China's real estate to GDP ratio is about the same as Japan's in 1989, with a housing to GDP ratio of 3x.

Currently, China's debt-to-GDP ratio exceeds the U.S., although it is still smaller than Japan, which takes the crown as the global leader in debt-to-GDP ratio.

China's model of GDP growth at all costs, at the expense of wealth, must one day come to a halt. For example, it was recently revealed that China overestimated its population by 100 million and is shrinking for the first time in 60 years, contrary to what was previously believed to be a massively growing nation.

Certain things such as China's ever-growing trade surplus over the past 25 years is also a major factor in China's economic model, although times have changed greatly since then. Will China be able to grow its surplus indefinitely, as it has in the past? We doubt it will.

Still, even if certain elements of GDP are overestimated, there is much reason to believe that the Chinese stock market should not be where it was 25 years ago, as most people see that much progress has clearly been made since then.

There are also reasons to believe that Alibaba will benefit because it is a company the government would rather not be without. It would be about the same as the U.S. trying to shut down Amazon. Too many jobs and too many consumers depend on the company, and it is seen as one of the most valuable assets in the economy. Anyone would have too hard a time getting rid of it.

And maybe China is uninvestable. But we think Alibaba is one of the few that subverts that rule and still falls into our circle of competence, because of its sheer size, low valuation and its growth prospects. Or maybe, if investors can't stand the heat, they should stay out of the kitchen.

The Bottom Line

Although China may face some headwinds today and in the coming year, we think the market is in a bottoming out process and ready to trade above that Hang Seng trend line of 15,000.

In our opinion, Michael Burry also probably sees China as undervalued, having bought 50,000 shares of Alibaba and some other Chinese companies. Based on EV/EBITDA and P/FCF, it is just too cheap to ignore, and the rewards currently seem to outweigh the risks with an IRR over 20%. If the stock returns to all-time lows, we consider it a strong buy.

Those near-term headwinds, such as a macroeconomic downturn as we mentioned, or tensions such as recently with Chinese spy balloons ratcheting up tensions, should dissipate at some point in our view. And when that happens, Alibaba is poised to run.

The Chinese behemoth said it was testing an artificial intelligence-powered chatbot internally. It did not share details of when it would launch or what the application would be called.

"As a technology leader, we will continue to invest in turning cutting-edge innovations into value-added applications for our customers as well as their end-users."

Alibaba's Hong Kong-listed shares ticked up 1.4% on Thursday morning.

At this point, Apple might as well just go ahead and announce it is working on a ChatGPT rival.

As reported by CNBC, Alibaba, the Chinese technology giant Alibaba has announced that it is working on its own competitor to ChatGPT, the conversational AI developed by OpenAI that has taken the tech industry by storm over the last few months.

If it seems like everyone is rushing to develop an alternative to ChatGPT, you're not wrong. Chinese online commerce heavyweight Alibaba has confirmed to CNBC that it's working on its equivalent to OpenAI's hit AI chatbot. The company isn't detailing features or offering a release schedule, but says it has been developing generative AI since 2017 and is in the middle of internal testing.

The reveal comes as multiple tech giants have introduced rivals to or spinoffs of ChatGPT this week. Google unveiled Bard, while China's Baidu said it was testing "Ernie Bot." Microsoft, meanwhile, launched a redesigned Bing that uses a "much more powerful" language model built with OpenAI's help. The text-generating AI is considered particularly useful for search, where it can provide detailed responses to very specific questions.

Alibaba hasn't said how it would put the AI to work. However, the company is a powerhouse in online shopping and has its fingers in numerous other fields ranging from cloud computing through to finance. A counterpart to ChatGPT could be useful in many of these categories, and might help Alibaba challenge Baidu and other Chinese firms hoping to wield AI as a competitive advantage.

Alibaba.com Singapore E-commerce Private Ltd sold 21.43 million shares of One 97 Communications, the parent company of Paytm, at 642.74 rupees apiece, according to Friday data from India's National Stock Exchange (NSE). The deal is worth about 13.77 billion rupees ($167 million), according to CNN calculations.

In January, Alibaba sold about 3% of Paytm for $125 million, cutting its holdings from 6.26%, based on NSE data.

With Friday's deal, it has sold its entire direct stake in Paytm.

Shares in One 97 Communications plunged nearly 8% on Friday. It bounced back slightly on Monday morning. Alibaba and Paytm didn't immediately respond to CNN's request for comment.

CNN's Simone McCarthy contributed to this report.