J Capital Research’s Anne Stevenson-Yang presentation on “Long and Short the China Dream” in which she talks about when to short Alibaba.

China has been a Silicon Valley ca. December 1999–since 2006.

  • China’s excess of capital leads to focus on volume growth over profitability.
  • Continuing fragmentation from regulatory and financial sources.
  • Executives are rewarded for raising capital and use that in turn to create their own growth.
  • Cash is power: important to hold a lot of it
  • But cash also makes companies a target for the government.

Neither source of large capital flows, State or foreign, offers any real return.

Alibaba Group Holding Ltd (BABA)

  • State fiscal resources are ported to the banks and re-invested in State companies, which use the capital to generate top-line growth.
  • The growth story prompts foreign investors to bet more heavily on the 1 billion shirttails story.

The currency is the ultimate corrective.

Alibaba Group Holding Ltd (BABA)

Poster children

Alibaba short

  • Current price: USD 75.86
  • Target price: USD 36.58
  • Market cap: USD 188.83 bln
  • P/E: 18.43x
  • Av volume: 8.83 mln shares

[drizzle]Tingyi (0322 HK) long

  • Current price: HKD 7.77
  • Target Price: about HKD 15
  • Market cap: HKD 43.65 bln
  • P/E: 16x
  • Av volume: 15.85 mln shares

Four reasons to short Alibaba

  • As an ecommerce platform, it’s maxed out
  • A terrible investor of shareholders’ money.
  • Likely using investor capital to generate its own revenues.
  • The Chinese e-commerce story is exceedingly unlikely.

Maxed out?

Alibaba Group Holding Ltd (BABA)

  • Ebay, whose model is the same as Alibaba’s, reports 10.5%.
  • Baba’s calculated rate is 3% despite its monopoly status. This is probably a function of overstated GMV.

Components of misleading GMV

  • Uncompleted and returned orders
  • Balance transfers
  • Fulfillment cost
  • Free-of-charge wholesale transactions
  • “Craig’s List”-style listings of industrial goods etc. closed outside the platform but that count in GMV.
  • Reciprocal purchases to acquire volume, credit card points, or to move product through tax-efficient localities
  • Brushing or totally faked orders

Dubious assets

  • Alibaba has accumulated USD 25.8 bln in goodwill, intangibles, and investment in associates (at end 2015 exchange rate).
  • The acquisitions have virtually no accretive value.
  • Our research on companies like Wasu Media, Citic21, Koubei etc. suggests that friends and family are probably being paid more than the companies are worth.
  • Many of the acquisitions—Haier assets, Evergrande’s soccer team, Suning, Intime—look either like loans or like seeding own revenue.

A little help for Alibaba’s friends?

Alibaba Group Holding Ltd (BABA)

The company carried $25,870 bln in such assets as of December 31.

Whom is the company being run for?

  •  Share-based compensation is about 16% of revenue and 35% of profit.
  • Even as revenue rose 45% in FY2015, income from operations declined by 7% “due primarily to a significant increase in share-based compensation expense.”

Alibaba is the most profitable of all e-commerce companies. So why does it need so much capital?

Alibaba Group Holding Ltd (BABA)

And it’s just really unlikely

Alibaba Group Holding Ltd (BABA) - 6

  • Using 2013 numbers, the Chinese retail industry was measured at USD 3.71 trn. The US retail was about USD 4.5 trn that year. Therefore, Chinese retail was reportedly 83% of U.S. retail. But the U.S. economy is 40% larger than China’s, and US consumption is more than double Chinese as a proportion of GDP.
  • Alibaba continues to accelerate as the rest of the economy declines. Category sales on Alibaba are greater than all such category sales recorded by the NBS.

When to short Alibaba: Watch the capital flows

  • Alibaba has already issued equity and two tranches of debt. It also borrows from its merchants.
  • For BABA, incoming capital makes it possible to create GMV and revenue. The group will try to IPO Ant Financial and eventually China Smart Logistics. BABA may also issue new equity and debt. If it cannot get these fundraises out, the coast will be clear to short.
  • It seems significant that no Chinese banks are involved in the IPOs, bonds, and credit facilities.

Long: Tingyi

  • Tingyi is the largest maker of instant noodles and beverages in China, with annual sales of ~USD 10Bn
  • Tingyi is a play on instant noodles
    • Noodles comprised ~97% of Tingyi’s earnings in 2015
    • Tingyi’s beverages business comprises ~60% of sales, but a small fraction of earnings due to the listco’s 47% ownership of the beverage business and lower OP margins in beverages
  • Tingyi has a long runway for growth in noodles in China
    • Noodle consumption per capita in China is half that of Taiwan and HK
  • There is an upgrade path to bowl noodles from packet noodles
    • In Taiwan, cup and bowl noodles make up 47% of the noodles market. In China, this figure is a scant 17% of the market. Cup and bowl noodles cost 3-4x the price of packet noodles
  • Tingyi dominates the bowl noodles market in China
  • Tingyi’s market share in bowl noodles is especially strong at 67% of the market, vs. its overall market share in noodles of 44%

See full presentation below.

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