Alibaba’s Gazprom moment — Three Body Capital

We’ve been thinking of writing this piece for some time, even before the events that unfolded late last year. So when all the opinion pieces came out, we decided to wait and see how the dust settled before committing our own thoughts to paper. There are many excellent opinion pieces out there both for and against Alibaba. Here are links to 2 other pieces we enjoyed from Packy McCormick (in favour of Alibaba) and Lillian Li (against Packy M’s piece). As ever, our musings are a base path we choose, never closing the door to other paths that may emerge. We know many of our readers are Alibaba bulls and as such may consider this piece to be rather heretical. In fact, one of our colleagues has actually spent time working at Alibaba’s Hangzhou campus over a summer, which gave some interesting colour and context to what goes on behind closed doors. Whatever your views may be, we would love to debate with you!

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In 2007, wide-eyed and bushy-tailed, entering the exciting world of emerging markets, a parallel universe opened up. At the time, the internet was (still!) nascent, and didn’t yet permit access to the information and learning that is possible today. As a result, most of the learning about companies took place from direct person-to-person relationships, either by frequent travel or over the phone to countries very far away. When arriving in London, one of the first places visited was Russia, as part of an investor trip. It was simply mesmerising! In the good old bull market days, we travelled quite literally all over the country in the space of 5 days. Sleep was not important (nor possible). Our travels took us from a permafrost-covered Norilsk to the glorious, green, Siberian-forests of Abakan. We stopped off in Magnitogorsk (grim) along the way to the final point in Moscow which was quite simply a feast of excitement. It sparked a bug from which I have never recovered. Russian history is some of the most colourful around and book after book, conversation after conversation was inhaled to try and understand what it was that makes the country tick.

That original trip coincided with a massive boom in the country as oil prices were repeatedly breaching all-time highs. And after several years of perceived “reforms”, Western capital was flowing liberally to this hot new emerging market. Forgotten was the Yukos fiasco; the poster child of the time was Gazprom. There was no stopping the stock price and it roared to high after high. It was everything investors wanted, a former communist giant, modernizing and reforming. A global gas behemoth benefiting from its oil-linked gas price structure at record oil prices while, as many analysts at the time put it, “printing cash”.

But as we now know, that turned out to be the best of times. Russia began to flex its muscles first with its Georgian sortie and then its emerging bellicosity to the West. It became clear that all was not as it seemed. Oil prices did peak in 2011 but by then the game was up. From 2011 until 2017, Gazprom’s stock price de-rated as it became more and more apparent that the cash Gazprom was generating was quite simply not for the benefit of minority investors. It was far more useful in the form of continually higher taxes or inside the company where it could be spent on anything that the Russian government needed. The substantial contribution to the 2014 Sochi Winter Olympics is a personal favourite.

Yet year after year Gazprom appeared on all the top pick lists from analysts far and wide because it screened so beautifully on paper. The world’s largest gas producer available at incredible free cash flow yields and ever-lower earnings multiples was too good to resist.

You must be thinking this is a great story but what on earth does this have to do with Alibaba? Alibaba is not a gas company, its digital!

Whether it be for the core ecommerce offering, the exposure to Ant Financial, the explosive growth in cloud or the many other opportunities in video, services etc, on paper surely Alibaba should be at the core of every emerging market, and possibly even global, portfolio. Well, it already is – Alibaba is almost 6% of the EM index, and is held as a top holding for most institutional managers.

On paper Alibaba is valued cheaply having de-rated in valuation especially after the recent string of news flow on Ant Financial’s “postponed” IPO and Jack Ma’s “disappearance”.

Much like Gazprom then, Alibaba is now appearing on all the analyst top buy lists as we speak.

Remember the supercycle?

Who remembers the commodity supercycle? The previous one, that is. It was driven by Chinese industrialisation. And that industrialisation was policy-driven in a country where policy matters more than it does anywhere else. The inflection point was in October 2010 when the Chinese announced its 12th Five-year plan. The plan called for a shift from an investment-led to a consumption-led economy, putting an end to the “commodity supercycle”, and starting up a new supercycle. The 13th Five-year plan in March 2016 called for increased innovation and a shift to a modern “information sensitive” economy. These policies set the tone for the development of an incredible period of digitisation in China, primarily led by Alibaba and Tencent.

For many years, much like Gazprom’s positive narrative in the 2000s, the narrative around the pioneering Alibaba was one of high growth, technological leadership and dominance of everything it touched. A company responsible for the dawn of a new digital era in its country (which happened to have the largest population on earth). It was about a charming leader who went from rags to riches with his smiling face all over the international media. It was about how China went cashless long before the West even knew what a QR code was and how Alipay was connecting the unconnected. It was about how AliCloud was in its infancy with an “AWS” like growth trajectory. It was even about making the nearly-lost physical retail world go digital. And most importantly it all happened!

It was a time of dreaming about competing with Apple and Amazon to be the first trillion-dollar market capitalisation stock on earth. After all, why should America have a monopoly on the world’s largest companies?

And then suddenly it wasn’t.

The apparent turning point was Jack Ma’s “non” disappearance and Alipay’s “rugged” IPO - these are critical, as we shall soon examine. In reality, Alibaba today faces incredible amounts of world class competition across all its verticals. As Kai-Fu Lee put it in his book, AI Superpowers, the Chinese competitive arena is bloody and the companies are like gladiators. There is no mission focus like in the US. Here it is “win at all costs” or die trying. And unlike those years ago, today Alibaba faces several powerful fighters. Tencent, Meituan, Kuaishou, Bytedance, Pinduoduo, JD, Bilibili – to name a few. These are not small competitors. They are behemoths who have all discovered the power of stock markets. And many are winning.

And as the years went by and policy became reality with China becoming the most digital major economy on earth, Alibaba (and the rest) became too important to the system to leave in private hands. A failure to control these “national champion” companies would mean a failure to control the economy and its direction of travel. Whatever the Chinese Communist Party may have planned for its country, one can be sure that its interests will be served first. Our base path is that the country and the system’s needs will supersede those of minority investors in the long run. Where both interests can be well served (as they have been for many years up until recently), minority investors will benefit – just as it was with Gazprom.

But correlation is not causality. There will come a time (maybe it already has) where the choice will need to be made, and our base path is that minority investors will come second. And that is why the Ant Financial and Jack Ma events are important. We will most likely never know exactly why the IPO was pulled nor whether Jack Ma went quiet on his own accord, but in a political system where control is everything, even a tiny perceived political threat is an existential risk. And once the public reaction to Mr Ma’s speech was out, there was little doubt as to what could unfold.

Welcome to the new world

So, to unpack it all, Alibaba is becoming a value trap. It is facing the most gladiatorial competitive environment we have seen yet and whatever one may think about the events surrounding Jack Ma and Ant Financial, it’s hard to argue they are a positive. The recent events surrounding the company serve to undermine the trust and confidence of investors, and the genie is out the bottle.

Yes, Alibaba is still a national champion and a wonderful business. Yes, it is cheap on paper. But the STOCK market is made up of stocks and not companies. The multiple, as we like to say, is the market’s collective imagination of it wants to pay for a company’s earnings, and the evolution of a stock from “growth” to “value” is not a place where we like to play. Not on the long side anyway.

When the argument to buy is based on valuation, the battle is being lost. Alibaba used to be sexy, pioneering and exciting. Today it is “cheap”.

One only needs to look at the performance of the leading candidates: Meituan, Tencent, Pinduoduo and the rest are breaching new highs every week while Alibaba languishes below. Price is instructive as always.

Alibaba’s Gazprom moment has come, and our base path is that there is no going back.