Alibaba is fairly valued if it keeps growing at more than 20%. Undervalued if multiples expand in 2030.
At HKD$195, it is trading at a Price to Free Cash Flow of 19x
I’ve been buying Alibaba since December 2020 for my family’s portfolio. I started purchasing shares on the Hong Kong Exchange at HKD$233 / share and i’ve been buying a lot (100 shares) every month since.
I believe Alibaba is undervalued currently if it keeps growing at 20% and Free Cash Flow multiple contracts from 19x to 15x in 2030.
Fast & Dirty Numbers
Revenue growth from 2016 to 2020 : 4.7x
Free Cash Flow growth 2016 to 2020 : 4.1x
Debt to Cash : not an issue. This business can pay off all debts with a cheque
Worst Case Assumptions
Revenue & Cash Flow keep growing 10% a year until 2030.
Company gets Revenue multiple of 3.5 in 2030 and FCF multiple of 10 in 2030
Revenue in 2030 : US$216bn
Free Cash Flow in 2030 : US$70bn
Revenue based Value (3.5x) : US$756bn market cap
FCF based Value (10x) : US$700bn market cap
Share Dilution : Between 2011 and 2021, Alibaba issues 16% more shares. Let’s assume dilution is 20%.
Taking the FCF 10x model (US$700bn) and 20% dilution (3.30bn outstanding shares), the expected share price in 2030 will be HKD$ 212.
Based on my average purchase price of HKD$220, I would be 4% down on my entire position. Taking inflation and opportunity cost into account, the fall is arguably far more severe.
Realistic Conservative Case Assumptions (15% annual growth)
At 15% FCF growth a year, FCF in Year 2030 will be : US$102bn
FCF 10x multiple : US$1.02T business
Assume 20% dilution : 3.3bn outstanding shares
Share price in 2030 : US$309
Annual Return : 4%
Weighing Risk & Reward
An investment in Alibaba requires some relatively bullish assumptions. To get a 10% annual return over 10 years, including 20% dilution, Alibaba’s market cap has to grow to roughly US$1.6T
Assuming this happens and multiples contract, Alibaba must hit the following numbers :
3.5x Revenue (Revenue must be US$457bn in 2030)
10x FCF (Free Cash Flow must be US$160bn in 2030)
This means that Alibaba must grow 5x in 10 years or roughly 20% a year (half the growth rate of the last 5 years). A business as large as Alibaba growing 20% a year is bullish. If you don’t believe this is possible, Alibaba is overvalued today.
If the China narrative changes and the secular bull market pushes valuation multiples up to 15x FCF, Alibaba could hit a market cap of US$2.4T, yielding a 20% diluted share price (3.3bn outstanding shares) of US$727. This is roughly a 13% annual return for 10 years on a share price of $220. Placing a 15x FCF multiple on a business growing 20% is arguably low.
I think a large, dominant business like Alibaba, operating in a large and growing economy like China stands a good chance of exceeding conservative expectations. It has a good risk-reward profile and justifies a heavy weighting in my portfolio.
Why doesn’t Alibaba deserve more bullish assumptions?
It is a large, sprawling conglomerate and it is unclear how efficiently it can compete in the various segments (food delivery, logistics, SEA e-commerce etc) it has entered. Read Lilian Li’s article in Further Readings below.
I believe Alibaba should be valued like a Costco or a Walmart, rather than like an Amazon. At least until the future of Alibaba Cloud becomes more apparent. China’s SaaS and B2B software markets are relatively new and underdeveloped, so you cannot place a 10 year value on that and accrue it to Alibaba Cloud….yet.
I am an optimist and believe that Alibaba Cloud will grow and today’s price gives me the cloud cover to allow that future to pan out. Failing which, I can reasonably pocket a 5-10% annual return.
Further Readings (Bull & Bear) about Alibaba
Legal Disclaimer : This post is opinion and not investment advice. The author is not a licensed financial advisor and merely some guy writing stuff on the internet. The author is not liable for any investment loss the reader (you) incur from acting on information written by the author.