Alibaba currently has a bigger problem on Wall Street than reviving the Ant Group’s IPO: the company’s failure to create value for equity holders, which may explain why its shares remain significantly undervalued.
Gurufocus.com puts the Chinese internet giant’s intrinsic value at $368.61, nearly three times the current market price of $119.62.
Intrinsic value measures the value of shares and other assets based on the discounted cash flow they generate for their holders. Value investors often use it in search of bargains. They quickly steal the shares of undervalued companies. “Mr. Market”—to use Benjamin Graham’s terminology—will align market price with intrinsic value.
What’s Missing Mr. Market in the case of Alibaba? Why don’t value investors rush to buy Alibaba shares to close the gap?
Because what looks like value is a value trap. Alibaba creates many cash flows that increase its intrinsic value but destroy rather than create value for equity holders as measured by the Economic Value Added (EVA) concept.
EVA, the difference between Return on Invested Capital (ROIC) and Weighted Average Cost of Capital (WACC), is a crucial concept in bond analysis. It is used to measure the strength of a company’s competitive advantage: the higher the EVA, the stronger the competitive advantage. In addition, EVA indicates how efficiently publicly traded companies manage other people’s money, seeking excess market returns.
Alibaba once created a large amount of EVA, according to Gurufocus.com estimates. This was before 2013, when the company had close ties to the Chinese government, helping to keep competition out of the Alibaba market.
Somewhere along the way, relations with the Chinese government soured and competition from JD.com Inc. and Pinduoduo caught up, eroding Alibaba’s EVA. It is now at -3%, down from 42% in 2013, according to gurufocus.com. A negative EVA is an indication that Alibaba is destroying rather than creating value as it grows. It’s a value trap.
Still, investor Eric Schiffer thinks the worst is behind Alibaba. “Regulators and COVID have created a perfect storm of capitulation among investors in Baba,” he said. International Business Hours. “Baba’s underlying forces are being reversed through government easing of financial conditions, COVID easing, and regulators pulling back on technology – all presenting investors with big upsides over the next 2-4 quarters.”
Harrison Rogers, CEO of HJR Global, isn’t so sure about this. “Alibaba’s risk profile remains quite high for equities,” he told IBT. “The uncertainty of the Chinese regulatory environment, which can change by a dime, means you could see big swings in stock prices continuing in both directions.”
Tyler Tucci, head of research at SynerAI, will stay away from the company’s stock after recent gains, seeing stocks fall again. “A drop to $65 a share this fall isn’t off the table, so we’re not in much of a rush to buy here after it moved nearly 50% below its May lows,” he told IBT.
© Copyright IBTimes 2022. All rights reserved.