At 97, you might not expect legendary investor Charlie Munger to have much patience with Beijing’s regulatory chaos these last 12 months. You’d be wrong, as Warren Buffett’s right-hand increases bets on Alibaba Group.
Alibaba is China Inc’s “patient zero” on two fronts. It was the first big tech-sector success that President Xi Jinping’s economy put on the global scoreboard. Founder Jack Ma was also the first tycoon Xi’s Communist Party went after, when it scuttled a November 2020 initial public offering by Ant Group.
Is the worst over for Alibaba, whose shares are down 45% over the last 12 months? Amazon, by comparison, is down a less spectacular 5%, while Japan’s Rakuten Group is down about 10%.
Count Munger as a solid “yes” on Alibaba, which is, indeed, rallying this week. Last week, the Berkshire Hathaway vice-chairman’s Daily Journal firm disclosed that it had increased its Alibaba position by roughly 83%.
Translation: one of the globe’s most fabled value investors thinks Alibaba is due not just for a break from regulators, but a bull run as 2022 approaches. Emphasis on the latter development, in Munger’s apparent thinking: He has upped his holdings in the Chinese e-commerce and cloud giant to more than 302,000 shares.
The bull thesis on Alibaba goes like this. After several months of regulatory crackdowns and Ma effectively being disappeared, Alibaba’s leadership found religion and saw the light. The company has kept its head down, invested in its own core business – a natural winner amid the Covid-19 pandemic – and doubled down on cloud computing.
This latter focus is already paying dividends. Though Alibaba missed analysts’ expectations in the first quarter, its earnings per share performance impressed thanks to a 29% revenue jump from the cloud business. Considering that cloud is only the third-fastest growing segment of the company’s four main ones, this leaves considerable room for growth.
Another leg of the bullish-on-Alibaba trade: hints are that Xi’s inner circle thinks it made its point that monopoly building won’t be tolerated.
After the shelving of Ant’s US$37 billion IPO and the regulatory turmoil of the last several months, the odds are high that Ma’s fellow tech titans from Tencent Holding to Didi Global also heard the message.
Perhaps that’s why Ma’s $469 billion e-commerce giant now has zero sell ratings, according to Bloomberg. In fact, fully 36 of 38 analysts have Alibaba as a “buy.”
So what is happening in Beijing? Xi and his top brass may have internalized headlines overseas. Surely, they realize the damage the last 12 months did to China’s reputation as an investment destination. Being Asia’s biggest economy and boasting rapid growth is great. But Xi’s tech crackdown worked at cross purposes with the need to woo foreign capital and earn the trust of western investors.
Prior to the crackdown era, Xi’s biggest accomplishment had been internationalizing his financial system.
The first big win came in 2016 when the People’s Bank of China succeeded in getting the yuan added to the International Monetary Fund’s special drawing rights program, making it a top-five currency. Next, Xi’s team had Chinese government bonds added to global debt indexes, most recently FTSE-Russell benchmarks.
Stocks, too. After years of lobbying, mainland shares in 2017 won inclusion in MCSI’s indexes. Such openings coincide with Xi’s government increasing the number of channels between mainland stock markets, Hong Kong and the broader world.
Supporting the development of mainland bourses and keeping government bond yields low is vital to China increasing its appeal as an investment destination.
Even so, the odds that Munger’s optimism is misplaced are far from negligible.
The Chinese Inquisition
Even if Xi throttles back on the inquisition of the last year, Fintech and internet companies still live in a world of uncertainty. It’s pretty clear that Xi is determined to avoid the tail-wagging-the-dog problem Washington has with Facebook, Google and other big tech platforms. The worry is that his methods are too draconian.
That’s particularly true considering that the future of financial risk in China hangs in the balance. One of Xi’s overriding objectives in policing Ma’s Ant was, ostensibly, to avoid too-big-too-fail financial companies, regardless of the platform.
Xi’s men are dealing with quite enough of that from the property sector this month.
China Evergrande Group faces additional debt payment tests this month after missing recent ones. That resulted in the suspension of more than half of the most indebted developer’s 800 projects across China. As Evergrande struggles to sell assets and attract investors, attention is turning to smaller players like Fantasia Holdings.
If not contained quickly, these troubles could spread not just across China’s most vital industry, but the entire $14 trillion economy. The crisis has prompted the PBOC to pump hundreds of billions of dollars of liquidity into markets.
But Xi’s economy is now facing another challenge: the likelihood that the global recovery has “peaked,” according to analysts at Fitch Solutions. That means that, on top of supply-chain snafus undermining growth, China will be exporting less. Surging energy costs are sending even more headwinds China’s way.
Given efforts to deleverage the economy and avoid real estate bubbles, the PBOC is under pressure to keep new monetary stimulus to a minimum. And local governments are already struggling under crushing debt loads built up since the 2008-2009 Lehman Brothers crisis.
As investors fret debt tremors under the economy, they’re also left to wonder what regulators might do next from the top down.
China bulls versus China bears
Yet to Munger and his ilk, Xi’s men are likely to go easier on the tech sector in the last three months of 2021. This is also the view at BlackRock Inc headquarters in New York. Though marquee-caliber risk-takers like George Soros think Larry Fink’s team is making a terrible “blunder,” BlackRock is pushing ever further into the second-biggest economy.
The “tragic mistake” Soros thinks BlackRock is making, and therefore “likely to lose money,” is ignoring how Xi is dragging China backward.
Count Brad Gerstner, CEO at Altimeter Capital, as among those worried Xi is creating “radical uncertainty” that makes China a risky bet.
“China is now a national enterprise with one CEO and it is the president of the country,” Gerstner explains. “You no longer have any of the major founders actively involved in the internet companies and I don’t think we will see additional Chinese IPOs in the US. All will be directed to Hong Kong.”
Gerstner adds that “make no mistake, there will be a lot of economic growth in China.” The coming Winter Olympics, he says, are sure to incentivize Xi’s men to ensure “relative stability” for a while. But Gerstner appears to be leaning more in the Soros direction than the Munger or BlackRock direction.
China is, after all, less transparent than when Xi took power in 2012. The press, the internet, access to social media and, by many measures, corporate transparency have all moved in the wrong direction.
But that hasn’t stopped a who’s-who of investment banking giants from rushing to expand in China: BlackRock, Credit Suisse, Goldman Sachs, JPMorgan, Schroders and Vanguard, among myriad others.
In June, for example, JP Morgan applied to take full control of its mainland securities venture. It said it would grow its China-based staff by at least 17% by year-end.
BlackRock, too, which grabbed a 50.1% wealth-management stake in China Construction Bank. BlackRock is also rolling out a new exchange-traded fund investing in Chinese tech stocks. The globe’s biggest asset manager is prepping its iShares MSCI China Multisector Tech ETF.
Its launch coincides with the giant $7 billion KraneShares CSI China Internet Fund, or KWEB, which also is wooing loads of investors figuring Xi’s tech crackdown is winding down.
Alibaba’s return to the investment fold could be the good omen for which overseas punters have been waiting. The same could be true of Tencent, Didi and other tech behemoths. “Perhaps there’s an irresistible window of opportunity here,” says analyst David Moadel at Portfolio Wealth Global.
It’s clear, Moadel says, that in regard to Alibaba, “the cautious feeling is tied to the Chinese government’s harsh crackdowns on certain businesses,” particularly technology-related companies. “On the other hand,” he adds, “with every problem in the markets comes an opportunity. If you’re not willing to buy on peak fear, then you might miss out on some of the glorious upside that’s, hopefully, ahead.”
Moadel’s own bullish case on Alibaba is similar to Munger’s argument that recent fears about Beijing’s crackdown are overdone. Munger’s view boils down to looking beyond today’s dramatic headlines to the potential of the not-so-distant future. His take: “We can see the concerns with Alibaba, but let’s not forget that this is a massive company that has a huge presence in China.
“Besides, Alibaba is a forward-thinking business that has gone far beyond e-commerce,” Moadel adds. “Sure, the Chinese government might still cause problems for Alibaba. The worst of it may be over, though, and Alibaba still remains a giant business with bold, innovative spirit.”
Along with sizeable investments in cloud computing, Alibaba is branching out into other forward-leaning businesses and away from messier pursuits – like media.
A case in point is Alibaba’s recent $300 million investment along with venture capital companies in DeepRoute.ai, a self-driving car startup. The company develops its own proprietary hardware and software for its fleet of autonomous taxis.
Mary Erdoes, CEO at JPMorgan Asset & Wealth Management, says that while many Western markets are overpriced, “China has gone on sale.” Part of her own bull case is that the regulatory scrutiny making Ma’s 2021 so challenging will benefit the investment climate in the longer run.
“It is absolutely time to invest, not just in the Chinese market at large, but the companies which will benefit,” Erdoes says. “So many clients are underweight in emerging markets in general and very underweight in China. I think people should be focused on it. This is the time.”
As analyst James Cordwell at Atlantic Equities told Bloomberg, Alibaba has “gotten very cheap.” After all, the company Ma took public in 2014 is changing hands at 17 times forward earnings estimates versus a multiple of 25 for Tencent and 39 for JD.com.
Recent events “led to some speculation that we are getting toward the end of some of the regulatory scrutiny the sector has been facing,” Cordwell says. He also argues there’s reason to be optimistic that trade tensions between Washington and Beijing are easing. That could bode well for consumer spending in the globe’s two biggest economies.
Only time will tell if these are accurate readings of where Xiconomics is heading. Yet Munger’s sense that the worst is over for Alibaba and China Inc in general could indeed lead to more crowded trades in the weeks ahead.