Unlocking Value with Alibaba: Investment Team Round-up
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Andy Rothman, Investment Strategist:
I think today’s announcement that Alibaba (BABA) will split into six companies and explore IPO (initial public offering) opportunities has broad significance for China’s markets. Given Alibaba’s past problems with the government, I believe that this was a carefully coordinated announcement – along with Jack Ma’s return to China the day before – with senior Party leaders. New Premier Li Qiang, who has known Ma for many years, probably led the effort for Xi.
This reinforces a few of the key messages from last week’s Sinology, addressing concerns investors have had about the role of platform companies and entrepreneurs in China’s economy. It also suggests the government is ready to resume IPOs for the tech sector, presumably including in overseas markets.
Coming shortly after the legislative session that was the formal kick-off of Xi’s new government, this is in line with my view that Xi is focused on supporting consumer-led growth and on restoring confidence of entrepreneurs, specifically the tech sector. This should also quiet speculation that Xi loves hardware companies and hates platform companies, which are the main consumer of hardware. Xi is moving quickly on this, which supports the change in direction of macro data during the first two months of the year. China’s economy has clearly turned the corner and is on a path towards a gradual, domestic demand-driven recovery. Confidence among Chinese households and entrepreneurs began to return in January and February: retail sales, home sales, manufacturing and investment all improved compared to prior months. Sales at restaurants and bars improved strongly, suggesting that many Chinese have begun to shake off last year’s COVID-related trauma, and are ready to socialize and spend again.
Andrew Mattock, Portfolio Manager:
Splitting BABA into six units to act autonomously should be seen as a positive for future profitability, in my view, there has been a trend recently to focus on profitability rather than excessive subsidization of the Chinese consumer.
There is a long way to go in cloud and payments to make more money. Question still is how much they will be able to monetize. But profitability is coming from a very low base, so I believe this move reinforces the trends already seen in e-commerce.
It fulfills the government intentions to move the platform companies more fully to more open-architecture and level the playing field against other competitors that are currently stymied by the power of a conglomerate that uses its core businesses to cross subsidize and makes it hard for other companies to compete. Therefore, I think it should be good for companies that compete with these platform companies in any one of the six divisions to make more money as the sectors become more profit focused.
The IPO angle is interesting because if these business units IPO it could unlock underlying value especially if they now pursue more profits. I think if they IPO on mainland exchanges the unlocking of value could be huge. Alibaba now trades at 4x excluding cash, so as a base for unlocking value I think there is upside potential. A reference here is the Ant Financial IPO that was going to be done on the mainland. The value that this was going to list at before it was pulled was well above 4x.
The read-across for other companies is that if this is what the government wants to see then there could be unlocking of value that could take place in many other platform companies, including Meituan, and Tencent. JD has already sort of split off its units in logistics into JD logistics and Pinduoduo is predominately e-commerce.
Investors can also have more variety in which parts of these platform conglomerates they want to invest. At the moment, anything associated with digital development in China and software is trading at extremely high values in the A-share market, I think the potential for this part of these companies (i.e., cloud) to trade a higher could be realized.
Currently Alibaba has 50% of its market cap in cash, if these companies are going to be run autonomously and raise money via IPOs the question is what will happen to all this cash? Shareholder returns?
Given the current valuations of all these platform companies, I think it’s a risk to be underweight, given their prominence in the indices.
Inbok Song, Portfolio Manager:
For the Pacific Tiger Fund, we have overweight position in BABA. If executed, this is a great value unlocking in the sense that:
- They have built top-leading positions in the likes of the local service, logistics, cloud and international commerce, in our view.
- Some of the businesses’ profitability has been improving and their disclosures have gotten clearer than in the past.
- In terms of sum-of-the-parts, even with conservative scenarios, I think its core businesses are valued at low multiple and same applies to other businesses as well.
Taizo Ishida, Portfolio Manager:
I remain skeptical about the ‘robust’ consumption recovery in China, but I’m optimistic for Chinese companies. Jack Ma’s return and the breakup of Alibaba was likely no coincidence, which gives me renewed hope in the tech sector in China for the time being. I think the story of China is changing from “just macro” to “company specific stories”. China’s consumption is not dead yet, but it would not be as strong as before, in my opinion. Having said that, Asia Growth Fund is currently overweight in China/HK, compared to the benchmark.
As of 28/3/2023, accounts managed by Matthews Asia held positions in Alibaba, JD Holdings, JD Logistics, Meituan, Pinduoduo and Tencent. This information is presented solely for illustrative purposes and is not representative of the results of any particular security or product.
Pacific Tiger Fund top ten holdings as of 28/2/2023. Current and future holdings are subject to change and risk.
Asia Innovative Growth Fund top ten holdings as of 28/2/2023. Current and future holdings are subject to change and risk.