BABA - Alibaba: SoftBank Runs But You Shouldn't

2023-04-13 06:33:25 ET

Summary

• SoftBank is primed to cut its stake in Alibaba from about 14% to under 4%. The Masayoshi Son-led company wants to "limit its China exposure."
• BABA has sold off more than 10% since management announced its restructuring plans at the end of March. So investors who didn't chase the momentum surge have another chance now.
• We gleaned that BABA's $125 resistance level remains in play. Therefore, buying BABA well below that level is critical to improving risk/reward.
• Warren Buffett recently reminded investors how challenging it's to model geopolitical risks, even for a "fabulous enterprise" like TSMC.
• Therefore, investors must reflect a significant margin of safety for BABA and be demanding about it.

SoftBank Group Corp. ( OTCPK:SFTBY ) sent shockwaves through Asian markets today (April 13) as the financial media announced that the Masayoshi Son-led company would significantly pare down its stake in Alibaba Group Holding Limited ( BABA ).

BABA has pulled back more than 10% since announcing its plans at the end of March to restructure into six distinct business groups to be "more agile, enhance decision making, and promote innovation to capture opportunities in their respective markets and industries."

As such, the initial euphoria bolstered by a potentially shareholder-accretive move has cooled slightly. Hence, it offers investors who didn't chase the recent momentum surge another opportunity to strike.

We updated investors in our previous article (Strong Buy) as we upgraded BABA, seeing that the consolidation back then was constructive, with buyers returning to support the stock.

It was also timely, published before the announcement of Alibaba's structural reorganization. Management aims to unlock more value for shareholders on top of its existing stock repurchase program.

However, Son's decision not to buy back the prepaid forward sales contracts of SoftBank's BABA shares could potentially lead to more volatility ahead for investors, even though BABA remains significantly undervalued.

Why? The Financial Times or FT reported that while SoftBank is going on the defensive after getting hammered by the tech bear market over the past year, the move is also seen as necessary to "limit its China exposure."

Notably, based on BABA's holdings as of 31 December 2022, SoftBank owned 13.7% of BABA and is its largest shareholder.

The move is estimated to slash SoftBank's holdings below 4% . As such, the move has also triggered further selling in BABA today in the Asian markets, down nearly 2.5% at writing in Hong Kong.

However, investors don't seem to be unduly concerned with the selloff, likely mitigated by BABA's significant undervaluation relative to the opportunities from spinning off its independent business entities moving forward.

In other words, we believe buyers will likely continue to use downside volatility to pick up the pieces from the panic sellers as Alibaba moves ahead to unlock value. Makes sense?

BABA last traded at a market cap of $242.8B. Analysts' estimates suggest that Alibaba Cloud could fetch $50B in valuation, while its Cainiao logistics unit could fetch about $20B in valuation.

Morningstar's sum-of-the-parts or SOTP valuation suggests a fair value of about $172, close to its DCF estimate of about $177.

Using a 5Y DCF EBITDA model with an exit multiple of 9.8x, we gleaned a fair value estimate of about $167.4. We believe the estimate is reasonable, predicated on a fairly conservative WACC of approximately 15.5%.

Despite that, the DCF models may not fully capture the geopolitical risks implied in its WACC, as modeling it accurately could be highly challenging.

As such, we believe it's helpful to consider where BABA's critical resistance is, as it identifies where market operators are not keen to lift its momentum further.

Warren Buffett reminded us just how difficult it is to model for geopolitical risks in an interview with CNBC recently, as he spoke about why Berkshire Hathaway ( BRK.A ) ( BRK.B ) decided to pare down most of its stake in Taiwan Semiconductor or TSMC ( TSM ).

Buffett re-assessed his stake in TSMC based entirely on the " geopolitical tensions between China and Taiwan," but not TSMC's "business, management, or anything of the sort." He reminded investors that "geopolitical conditions were outside the company's control." As a reminder, he described TSMC as a "fabulous enterprise."

Hence, we believe it's prudent for investors to reflect a significant margin of safety below BABA's well-established critical resistance level of $125, discussed in our previous article.

With BABA having fallen back to the mid-$90s level, it implies a margin of safety of about 25%, which is reasonable for a Buy rating, but no longer a Strong Buy candidate.

Hence, we encourage investors to consider leveraging the volatility of SoftBank's decision to cash in on most of its stake to pick up more exposure in BABA.

However, as BABA's price action is no longer optimal, investors should consider layering in progressively, taking advantage of dollar-cost averaging opportunities.

Rating: Buy (Revised from Strong Buy).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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