We’re not happy with Alibaba’s (BABA) share price performance. It has been one of our rare losers in the Best Ideas Newsletter portfolio. Our thesis on Alibaba continues to be a long-term one, however, and unless China enters a 20-year bear market, never again reaching the heights of yesteryear, we’re not worried about it. But that said, we’re not oblivious to the near term and may lighten up on the dwindling position in hopes that a better, lower price can be established. We won’t do so without emailing an alert first, which is standard practice with newsletter constituents.
We won’t harp on Alibaba’s fiscal first-quarter results, released August 12, which showed revenue advancing nearly 29% and earnings coming in a better than expected at $0.59 per share. We thought the Street would be disappointed no matter what, and they were. Healthy gross merchandise volume, which grew to an incredible $109 billion, up $28 billion from the year-ago period, and strong monetization of mobile traffic in the quarter were highlights. For the first time in Alibaba’s history, mobile revenue exceeded desktop revenues in its China retail marketplaces. Unlike some of the dot-com “bombs” of yesteryear, Alibaba pulled in non-GAAP free cash flow of $1.54 billion in this quarter alone. That’s a solid level of free cash flow generation for a company that continues to invest rapidly in growth projects, the latest a strategic partnership with Suning Commerce.
The present-day situation with Alibaba is certainly different than that which happened to Facebook (FB), but we remember the trajectory of Facebook’s equity performance quite well. For those that may not remember, Facebook performed incredibly poorly following its initial public offering (falling well below $20 per share), only to quadruple in the coming years, to approach the century mark. Facebook’s initial offering was so bad that it was called the “Faceplant” IPO, and while we were quite skeptical following the initial issuance of Facebook shares, we’ve been calling the company undervalued since. We had an $80 fair value estimate on shares in early November when they were trading below $50. Frankly, we should have added Facebook’s equity to the Best Ideas Newsletter portfolio at the time we added options. Yet another mistake.
Part of the reason why we still like Alibaba has a lot to do with the Facebook story. For one, we haven’t seen anything yet (Alibaba has only been public since late last year), and we have every reason to believe that the long-term story at Alibaba is extremely bright. Not only is Alibaba fighting “bad press” regarding corporate governance concerns in the midst of a Chinese equity market collapse, but investors continue to evaluate overall performance of its monetization rate, which doesn’t necessarily give credit to the pace of top-line growth at the business. Still, the Chinese Internet giant’s mobile monetization rate was 2.16% in the most recently-reported quarter, up 67 basis points from last year’s measure and 43 basis points sequentially. The market seemed to be looking for something on which to base a sell decision on, but the measure showed strong improvement.
We continue to believe the right question investors should be asking with respect to Alibaba is not what its free cash flow will be next quarter or next year, but just how large and affluent the Chinese middle class will be in the coming decades and which company’s name is synonymous with e-commerce in the country. That’s Alibaba. We fully expect shares to face continued pressure until sentiment improves across China, but we think the company is a long-term winner. Yahoo’s (YHOO) shares will continue to trade in step with Alibaba news for the time being.