New CEO At Alibaba, Good For This Undervalued Stock?

Alibaba Group NYSE: BABA has been on a roller coaster ride during the past three years, from the stock reaching an all-time high of $319.32 and subsequently falling by as much as 81.8% to get a 2022 low of only $58.01 per share. This low price is second to $57.2 per share, a strong support price that was reached as far back as 2015 just a year after the company's IPO (Initial Public Offering).

Obviously, Alibaba has become a much larger, much more profitable company that has taken market share globally and is still growing by pursuing high-growth and high-margin ventures.

During the second quarter of 2023, Alibaba's management decided to split the company into six businesses; some speculate that this decision came to appease Chinese officials and divert from any anti-trust or anti-monopolistic accusations. Whatever the motivation may be, the fact is that splitting the Chinese giant will deliver significantly more value to investors who can acquire the stock at these cheap valuations.

A surprising event occurred on Tuesday when the company announced that it would be naming a new CEO to run the business moving forward, and all the pressure of the split would fall on this person.

Alibaba Going through Changes

Analyzing the fair value of the six underlying businesses subject to the restructuring and adding some assumptions to this value will bring investors to the top-side price target from analyst ratings of $180.0 per share. The broader composite of investors has not yet realized what this means for the stock today; as the Chinese economy begins to feel the government's latest stimulus rounds, these spin-offs will only rise in valuations to bring a larger payday for equity investors. Now there is a new variable to throw into the equation.

Ever since the scandal between Chinese officials and Alibaba's co-founder, Jack Ma, Daniel Zhang had been placed as CEO to run the company during what turned out to be one of the most challenging economic times for the nation and the consumer sector, considering that the stock price declined as much as it did, and the business is experiencing a cyclical low level of profitability, perhaps these were enough reasons to motivate the replacement.

Though a new position, the person taking the role is a familiar face, co-founder Joseph Tsai will take the reigns. Zhang will remain the CEO of Alibaba's cloud computing unit in preparation for its spin-off.

Shifting leadership this way, especially as the company readies its operations to be spun off, will likely reduce the government's motivations for intervening as they have in the past via crackdowns. The good news for investors comes not only from the company's severe undervaluation but from its relative standing amongst the Chinese internet commerce peer group.

Management also backs the viewpoint of the stock being on the cheaper end of the spectrum, as they assigned a $25 billion share buyback program still active from 2022, representing more than 10% of the company's market capitalization.

Subtle Hints

Relative valuations are the core of some strategies employed by the most significant hedge funds in the industry, as these valuation multiples may act as a window into the near-term future. Today, Alibaba trades for a 22.6x price-to-earnings ratio, higher than direct competitors in the space, such as JD.com NASDAQ: JD and PDD Holdings NASDAQ: PDD.

JD.com carries a 21.4x P/E, and PDD sells for a similar 20.7x, hinting at what the markets may be betting on for the future of China's e-commerce players.

By assigning a higher multiple of earnings to Alibaba, rather than its competitors, broader markets are willing to pay more for each dollar of current - and future - earnings from Alibaba. This willingness to 'overpay' relative to other alternatives in the same country and sector cannot be taken lightly, as these views usually have some catalyst or another already priced into the future.

One catalyst could be more favorable Chinese economic data, especially since the government keeps rolling out stimulus measures. Another could be announcing more favorable quarterly results, downright to the early delivery of a spin-off.

In either case, investors can buy one of the largest companies deriving most of its revenue from the fastest-growing middle class in the world, for a 13.8x price to free cash flow multiple.

Free cash flow multiples (a proxy for earnings) can more accurately represent the 'real' earning power for the underlying business; in this case, investors can assume that Alibaba is trading at a 13.8x price-to-earnings ratio. Considering this alternative, jumping nearly double to a multiple over 20.0x is another path to bringing investors to the top-side price target of $180.0 per share.