Here is an excerpt’s from Dan Loeb’s Q3 2014 Letter to Shareholders regarding Ali Baba (BABA). Enjoy!
Dan Loeb’s (Third Point’s) Comments On Alibaba (BABA):
In our Quarterly Letter two and a half years ago, we argued “the Case for Alibaba.” At the time, Alibaba held a leading market position that it was just beginning to monetize (the company had less than $75 million in LTM earnings). Today, the Company has continued its exponential growth, demonstrated significant margin leverage, and is expected to earn over $5 billion this fiscal year. Our enthusiasm for the Alibaba story has underpinned multiple investments at Third Point and now that the company is public, we have established a significant direct investment in Alibaba shares.
Third Point has met with management several times and is confident that Alibaba can generate long‐term value in its core markets and compete in new ones, making it a compelling potential multi‐year investment. The company has a substantial network effect that creates several large moats around its business, generating significant free cash flow for re‐investment and expansion as well as an unrivaled amount of data on Chinese consumers. We see continued end market growth in Chinese consumer spending and e‐commerce (as well as global e‐commerce) and continue to believe that Alibaba has considerable additional monetization potential.
The success of Alibaba’s IPO shows that we are not alone in our view that the company is positioned as China’s e‐commerce juggernaut. Alibaba’s metrics should appeal to growth, GARP, and value investors. We are most focused on Alibaba’s multiple hidden assets that represent under‐appreciated sources of value, including:
Aliyun / Alibaba Cloud Computing is Alibaba’s Infrastructure as a Service (IaaS) business (effectively the AWS of China). The unit can leverage the robust infrastructure Alibaba has in place to handle spikes in demand around the 11/11 sales holiday (which has ~9x the traffic of the average day). Since Alibaba only uses 12% of its peak capacity on an average day, the company can lease out its infrastructure to other businesses at extremely competitive costs. Our research suggests that Alibaba has the best IaaS platform in China and competitors are ceding the market to them. Gartner suggests that this will be a $5 billion RMB market in three years and it is Alibaba’s to lose.
China Smart Logisticsis Alibaba’s logistics JV (Alibaba holds 48%). The Company’s logistic partners delivered 6.1 billion packages in China for the twelve months ended 6/30/14. This was 38% more packages than UPS delivered globally in that time period. Courier businesses are competitive in China and packages can be delivered for anywhere from ~5‐22RMB. Taking the lowest delivery prices we have heard, applying that to 6.1 billion parcels and growing the unit numbers 30% annually suggests that the delivery portion of Alibaba’s logistic ecosystem will be a $17 billion business in 5 years. Applying this math to average delivery prices suggests a $33 billion business. Once warehousing and logistics is added in, the industry could be closer to $50 billion annually. Our belief is that while Alibaba doesn’t want to enter the courier business directly, they would work through the JV to help the ecosystem manage data to make logistics more efficient and intelligent. It isn’t hard to imagine this becoming a multi‐billion dollar income stream over time.
AliPay is an escrow payment service the company developed to ensure users felt safe transacting on the platform. Alibaba has indirect exposure to AliPay via its 33% interest in Ant Financial, which also includes merchant finance, insurance and consumer finance businesses. AliPay has grown into one of the most important financial companies in China and has over 300 million users (twice the number of PayPal) and 190 million mobile users. The average Alipay user transacts over 80 times per year. While almost 80% of transactions on Alibaba are paid for via Alipay, Alibaba only represents 30% of AliPay’ s business. AliPay runs their Alibaba volumes at zero margin and makes money on the off‐Alibaba portion. This portion is growing faster than the Alibaba portion of the business, allowing revenue to grow faster than TPV and profits to grow faster than revenue. If we apply Visa’s TPV multiple to AliPay, it would imply the unit is worth $80 billion and is almost 10% of the company’s current valuation. The Chinese payments market is evolving quickly and the regulatory environment can be fluid but AliPay is one of the most innovative companies in China and is structured to be very nimble. Bank of America Merrill Lynch estimates AliPay will earn over $2 billion in 2017 and argues for a $60 billion valuation for the unit (or an NPV of $7 per Alibaba share). Local brokers have made the case that AliPay could be a $200 billion USD business by the end of the decade. The common factor in all three hidden assets is that they are under-appreciated relative to Alibaba’s core free cash flow machine because they are only beginning to make money. We have seen Alibaba’s pattern for growing businesses and believe that they are inclined to focus on share over profits until they reach enormous scale. Once a business achieves ubiquity, profits can ramp very quickly.
We believe that Alibaba’s $200 billion enterprise value (adjusted for public stakes) suggests we are getting valuable call options in Aliyun, China Smart Logistics and AliPay/Ant Financial for free.