Alibaba's Value is now clearer as Regulations has Eased

Last week, the Chinese Government has again affirmed that the many rounds of regulation on the likes of Alibaba, Tencent etc. is nearing its end via a speech that the future economic growth of China will be supported with the rise of its own Internet platforms. 

While it is merely verbal affirmation with no real policy shown yet, the continuous regulations has resulted in Chinese economy slowing and China Internet companies have been firing their own locals in order to cut cost. 

What's Next for Alibaba?

Just by a single speech, Alibaba moved up 10%. However, to me what is important is that are we now able to value the worth of Alibaba as a sum of parts. To me, it might now be safe to evaluate Alibaba's value as the waves of regulations has cleared.

Base Case Scenario

Based on Alibaba's latest quarter (page 8), its e commerce business margins have dropped, international e commerce's competition has intensified and local consumer services has not been doing well. At the end state, it is likely the first 3 sectors will be making RMB$40 billion per quarter, while the Cloud division and Cainiao will only break even, earning RMB$1 billion each. Personally, it is difficult for Alibaba Cloud to be a successful as Amazon's Web Services which generates as much profit as its e commerce. This is because Alibaba Cloud's main market is China and the Chinese Government is still wary of Alibaba Cloud and has been asking government entities to shift to Huawei Cloud which is technologically inferior to both Tencent's and Alibaba's cloud offering. 

Excluding the RMB $28 billion impairment which is one time, I expect Alibaba, as a group, to be reporting profits of RMB $37 billion per quarter (USD$5.6 billion per quarter). Extrapolating to a full year, Alibaba might be a US$22 billion profit generating machine. Applying a 20 times P/E (which is 50% of Amazon's valuation), we are looking at a US$440 billion market cap, implying a 58% upside.

Bull Case Scenario

To me, the bull case is that its cloud services becomes as profitable as its e commerce division as China allows it to prosper- something that Amazon Web Services has achieved for Amazon. This means the doubling of profits and will put Alibaba at US$880 billion market cap at 20 times P/E. This is a 215% upside.

My evaluation

To me, the bull case is a little hard to believe because i don't forsee China ever allowing Alibaba and Tencent Cloud to rule over China's Internet and Payment Services like what Amazon, Microsoft, Alphabet have done to the Western World. 

The offerings and Technological innovation by these 2 China Tech giant are definitely as good as the latter 3 US companies. But because the Chinese Communist Government is wary of them in growing to be larger than the communist party itself. I personally don't think either of the 2 will become trillion market cap giants.

Hence my view is that Alibaba can grow to be a US$420-US$500 billion market cap. Alibaba's business offering is more diverse than Amazon's (on an apple to apple comparison) because it has a 'Google Maps" division, a payment service, a digital banking arm and a youtube equivalent in China. This means Alibaba is in fact an Amazon + part of Alphabet. However to even grow to even Amazon's value of US$1.2 trillion is never going to happen.

My estimate is at a price of US$186 (share price) or US$500 billion market cap, it is the upper limit of Alibaba's fair value.

Sell Down in Sea Group and What's next?

Sea Group has been sold down from US$370 on 20 October 2021 to US$87.62 on 22 April 2022. This is a 76% decline in share price.

Is this the end of the Sell Down?

The sell down in the past 6 months has been due to 2 reasons: (i) risk off behavior by investors due to interest rate hikes and quantitative tightening and (ii) companies failing to meet their own guidance or have growing losses.

The effects of (i) should be almost done, barring any surprises from the Federal Reserve such as a 75 basis point hike in May 2022. However what I am worried is Sea Group will report another set of poor results for 1Q2022 in June 2022.

Why a Poor Q1?

The growth of Sea's gaming arm has slowed as the popularity of Free Fire has plateau. In addition, while Shopee and Sea Money are growing, their losses are growing as well because these 2 segments are operating at negative margins. Hence, if Sea Group reports a loss that is of the same magnitude as Q1 2021, I expect another wave of sell down in June 2022.

Unless Sea Group provides an optimistic guidance that it is able to breakeven on an accounting basis in 2023, i doubt there is any other catalyst to move share prices up to its old highs. Given the current climate where investors are brutally selling off shares due to poor results and guidance, I expect Sea Group to suffer the same fate with its large losses. Investors will remember Sea has a few billion in bonds maturing in 2025/2026 and given its low share prices, bondholders will likely be redeeming in cash. This means Sea Group has to start putting in profitable quarters soon, otherwise a severe cash crunch is due in 4 years time if it continues burning billions in cash annually.

All in all, I expect another 25% fall in share prices, similar to what paypal experienced when it did not meet expectations. Sea Group is a prospect to look at after all the negatives are priced in. As mentioned in my previous post on Sea Group, my expectation is it has a valuation of US$95 (US$55 billion valuation). However, it is not a good time to buy now with prices offering too small a margin at US$87.62.

How much is Shopify Worth?

Shopify is a well known name in the e-commerce space for Canada and USA markets. It holds the number 2 spot in market share behind Amazon. Unlike Amazon, Shopify allows for its merchants to have customizable layouts for their e-commerce shops. Shopify earns from the subscription plans a merchant signs up to join its platform and the transaction fees for sales.

Verified Profitable Model

Unlike most start ups which promise growth and a large market share that can be monetized, Shopify has achieved this with an e commerce market share that is number 2, behind Amazon and is profitable in monetizing its user base. It achieved profitability in 2020, registering a core earning of US$90 million.

For 2021, its core profits tripled to US$268 million.

Shopify's FY 2021 results

How High can Profits Go?

I do not have a crystal ball but I will guess. With the post COVID-19 world, it is unlikely companies in the digital space will continue its blistering growth. I doubt Shopify can repeat a tripling of its core earnings this year; profits will grow by US$150 million to about US$400 million (55% growth).

Thereafter we will see a decade of 20-30% annual growth from growing revenue which will help profits, before an eventual plateau. This is because there is a limit to how much Shopify can take from Amazon in the growing e-commerce pie of the Western World and the inability to penetrate into China's market. 

Risk to its Business

The entire Western World is now in an interest hike tightening environment due to inflation. The first order effect is that consumers are going to tighten their belt and spend less. This  affects e-commerce spending growth.

The second order effect is a raising interest environment means it is more expensive for western countries to service their debts. Budget cuts may be inevitable which spurs less growth for the economy and in turn consumer spending.

In the short term, it is likely Shopify will announce US$2 billion in losses for its equity investments in other companies which it has marked up over the past 2 years due to the US market rally. The fear of interest rate hikes has wiped out most of the US companies equity gains.

Valuation of Shopify

Looking at FY 2022, I would expect US$400 million in profits. Followed by a decade of double digit growth of 20-30% with some downside in a changing monetary environment; a 90 times P/E to its core business earnings for FY 2022 is where I would invest. This is because I have to stomach a decade of risk that either the growth story does not materialize or a new entrant disrupts Shopify.

This values the company at a US$36 billion valuation. At current valuations of US$58 billion ($460 share price) or 145 times P/E, I think the market is baking too much optimism that Shopify will execute perfectly for the next decade. There is no margin of error. Hence, a further 40% of reduction of share price (US$276 to US$280) is warranted.

No doubt it is a company with a good growth story, but its current valuation is too high to justify it.

Yongnam - Weaken Balance Sheet with risk of default

Yongnam has released its latest full year results and it looks pretty scary. Unlike its competitor TTJ who has been eking out a margin in projects, Yongnam continues its path of losses. Despite government financial assistance for the construction sector, the margins earned are  negative and even on a gross profit view, it is not even making money. TTJ, Hocklianseng, KSH are profitable in their construction segments.

It points to reckless bidding by its tendering team. My speculation is for projects, they are bidding as the lowest bidder, without care for margins and people are accepting their bid because of their lowest value and track record of completing many national projects. However, the risk of them ending like Greatearth is now elevated. The public sector should keep watch for their projects with them in least it becomes like some recent BTO projects

Weak Balance Sheet

PPE Woes- The company is reporting positive NAV due to the presence of reported $215 million in PPE. This consists of steel strutting structure ($155 out of $215 mil). However, I do not think this is the true cost. In this latest FY, Yongnam has sold off steel beams (nett of depreciation) earning a cash proceeds of $22 million, however, it impaired $7.5 million as part of the sale. This indicates a possible impairment of 25% for its steel beams and columns (currently valued at $155 million)

Convertible Bonds- Yongnam has 9 million in convertible bonds due at an exercise price of 5 cents. Given its poor results and that share prices are below 5 cents, it is likely bondholders will ask for cash redemption. Yongnam currently is in a cash crunch and bondholders will likely levy for a higher interest more than the 7% or a severe dilution in shares such that their loss in principal is minimal.

October 2022 will be a crunch time.

How can Yongnam Turn Things Around?

Simply put the tendering team have to be more prudent. The way they are bidding as the lowest value candidate has caused the company to bleed for years. They cannot continue this and will have to increase their construction tender values. No doubt they will lose projects but it ensures the company becomes profitable and shareholders value are preserved.

The current management seems reckless thinking they can act like a tech start up who can burn money to grow market share in Singapore. This will not happen because locally their competitor TTJ holdings will survive due to its prudent nature. TTJ can cede market share but it will not exit Singapore because it is earning money from projects. Other foreign companies are in similar predicament as TTJ.

How Much is Palantir Worth based on Future PE Forecast

Palantir is a software company who has recently released its financial year results. Much fanfare has revolved around the company because it has a moat of a software which helps companies in their decision making and has little competitors. To me, the basis is indeed fair and justifies Palantir's growth story

Summary of latest FY results

The company is still loss making but has been narrowing its losses due to revenue growth.

Revenue growth is projected at 30% annually until 2025, but margin forecast has fallen to 27%. CEO has guided that it is due to increasing staff cost and the need to hire a larger salesforce.

Estimated Value of Palantir Per Share

In terms of growth forecast, Palantir has always been meeting its targeted forecast or even exceeding it. Hence, it is safe to assume the set out 30% annual growth until 2025 is reasonably sound. This means in 2025, full year revenue will be $4.36 billion.

It is the margins guidance which is the issue (it has been dropping from 30+% to 27% now). Assuming Palantir margins don't fall further and remains at 27%, 2025 PE will be $1.17 billion. With more shares issued due to its shared based compensation for employees annually, it is likely its share base will grow from 2.2 billion to 2.4 billion shares. Hence the expected EPS in 2025 is approximately is $0.48 EPS.

Assuming, it has 10-15% more annual growth post 2025, a PE of 50 is justifiable (given that earnings per share will still double in approximately 8 years time, 2033). This means the fair value of Palantir's shares in 2025 should be $24.0. 

Present value this figure with a discount rate of 10% returns, it means current share price should be around $18. It is undervalued at current prices and still slightly above my previous buy price when i decided to buy Palantir (I had assumed margin of 30% then).

Starhub FY2021- Not Great and a Stagnating Company

Starhub has released its FY 2021 results, revenue drop with slight dip in profit. Dividends totaled 6.4 cents for the year

Takeaways

Mobile ARPU is still declining (from $31 per user to $28 per user)

Broadband ARPU has grown from $29 to $32 and with that the segment's revenue has increased.

Borrowings has grown further by $200 million due to issuance of new bonds.

Outlook

With the re-opening of borders, it is likely Starhub's mobile revenue will buck its downward trend as tourism and more foreign workers will mean an increase in prepaid users. However, in the postpaid market, the existence of Myrepublic and Circles life will continue to pressure its postpaid ARPU.

All in all, I expect Starhub to grow its overall revenue slightly, however it will be negated by the growing interest expense from its ballooning debts. So dividends are likely to maintain at 6.4-6.8 cents region. My worry I also have is the declining population base of Singapore, mobile penetration is already high and unless Singapore imports more foreigners, the number of postpaid users in this country will decrease and this will affect Starhub's mobile revenue.

The 2021 10 year bond Starhub (2.48%) issued was of a low rate and the proceeds are likely kept to redeem bonds maturing from 2022. With the interest rate hike environment, it is unlikely Starhub will turn to bond raising. This means dividends will be capped and those holding perpetual shares, the redemption looks very slim. This is because at a step up rate of 4.95%, it is more attractive for Starhub not to use the cash to redeem perpetuals but to pay off bond notes (which mature all the way to 2031). 

Given how the economy is weaker since my last writing in Feb 2020, instead of expecting Starhub to be a dividend yielder of 5%, one can expect it to be a 4.5% yielder instead. The world has to drain off the liquidity it had created during COVID and this will take about 5-6 years to clear. At a 6.4 cents dividend and expected yield of 4.5%, owning Starhub shares in the region of $1.40 is acceptable. 

But 5-6 years down the road, Starhub has to grow its dividends as the global economy would be better and QE tightening will be the theme, at my expectation of a 5% yielder the company is slightly overvalued

Central Banks tightening means the Tech Industry now has to fight for survival

The tech sell off worldwide is something worth observing. With higher interest rates in the immediate future and central banks balance sheet run offs, investors will now demand that tech companies be profitable, becoming like other traditional companies.

The past decade of cheap money and venture capital success has allowed entrepreneurs to incubate loss-making businesses for probably the longest period ever. However all these are about to change.

Either companies become profitable or they die off

Like all boom and bust cycles, the inefficient and unprofitable ones will be weeded out. This is similar to the dot com boom era where "Mickey Mouse" companies sprang up, had unviable business models, raised capital with alluring stories, CEOs became a poster child and then kaput. We have seen this in the 2000s before and I didn't like the ending 

Of course, there will be survivors who turn out to be dominant forces in the next decade. However, they had a sustainable business model that was scalable to start with. And it seems the likely few are Tesla and Airbnb. (their share prices will follow similar to what Microsoft went through in 2000s)

How to be profitable?

Its simple- either increase your revenue or cut your cost. Netflix is now attempting to increase its revenue by raising its monthly subscription fees in its mature markets. Gone will be the days where there are free shipping for small value purchases, cyber vouchers given out daily and deep discounts (I am referring to what Sea Group and Grab have been doing).

Of course, the other way is to cut cost. Taking Palantir as an example: In its latest quarter, it earned about USD$392 million, however employee expenses made up approximately US$190 million (about 48%). This is a lot higher than the traditional companies where employee costs form less than 20% of revenue. Palantir definitely has to cap its employee expense as it grows; otherwise, Palantir will go bankrupt or have to issue an expensive round of share dilution. Sea Group and Grab too are in this category.

Cost cutting measures will involve to stagnate your tech worker's salaries or trim them. Everyone now knows the best industry to work at is Tech - chief reason the remuneration is good. However, the good times aren't going to last and I expect the Tech workforce to experience trying times soon. 

The era of accommodative monetary policy is gone. Tech companies have to tighten their belts and be profitable, otherwise they will be joining the tech graveyard of the 2000s.

Who are the winners?

Truthfully I want to say it is the China Tech companies. They have built up a profitable model, are sustainable and using their free cash to generate new products and segments. However, they have been hampered by their own government making them less competitive and unable to spread their influence of "Chinese Tech and Innovation" when fighting with regional competitors.

In the era of monetary tightening, they are in my '"winner list" with their profitable business model. Just look at the difference between Tencent Music and Spotify current financial results. Both are leaders in their respective markets and are serving about the same population market size. However Tencent Music is at least 4 times more profitable than Spotify.

Furthermore with China now going the other way of having monetary accommodative policies, they are in a better standing to fight global tech companies. 

If tech workers want to keep their job, working in a Chinese Tech Company is the safest bet.

And the Losers?

I feel the ride hailing and food delivery industries are in a serious problem. Ride hailing is a low margin business and worldwide all ride hailing companies are loss making. It will be difficult for them to be profitable unless they undergo retrenchment and price hikes (the latter  will make them less attractive options to consumers when compared to the cab business).

Food delivery too has the issue of being too cheap to the expense it is negative in profits. The plastic/ Styrofoam used in the Asian markets is very worrying environmentally. However, governments are reluctant to regulate/tax business on this either due to worries of causing loss of jobs or simply angering their voters.

I don't expect many food delivery and ride hailing entities to survive this current cycle of monetary tightening unless central banks turn tail on their current interest rate trajectory.