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The Biggest Investing Opportunity of 2024


9m read
·Nov 7, 2024

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There are some cheap stocks in this world, but as we know as investors in 2024, it's hard to find really large quality companies at cheap prices. Over the past few years, we've seen the S&P 500 hit all-time high after all-time high, and the companies found within it—the Apples, the Googles, the NVIDIA, the Amazons—they are similarly at all-time highs and really high price-to-earnings multiples. The tech stocks are thriving, and they're expensive.

But when you change your location to China, you start seeing the complete opposite. Their behemoth tech stocks—Tencent, Alibaba, JD.com, Bilibili, etc.—have seen nothing but share price declines over the past few years, when these businesses are arguably better competitively positioned than their U.S. rivals. These large share price declines have led many of the world's famous super investors to decide to buy in. It started with the late Charlie Munger buying into Alibaba. Then, Monish Pabrai entered the arena, buying Alibaba, however switching it out for Tencent. You've got Guy Spier holding Alibaba, Howard Marks holding Alibaba and JD, and even Michael Burry—the guy that chops and changes his portfolio like a trader—is continuing to hold Alibaba, JD.com, and Bilibili, and has held particularly JD and Alibaba now for the last 18 months.

So what do these big super investors of the world see in these businesses? Why are these strong tech giants trading at such low valuations, and are there things that investors need to be wary of?

China is an interesting place. It's got a massive economy, and one of the reasons for that is because of the population size and its political system. Now, I'm not here to get political, but those two factors have inadvertently caused a beautiful business environment for these Chinese tech stocks to flourish. Because China limits or outright bans large Western technology companies from competing in China, it has given companies like Tencent, Alibaba, JD, and Bilibili a very nice environment to grow very quickly.

The wealth of the average Chinese citizen has skyrocketed over the last few decades. The massive population has had money to spend, and the Chinese government has shielded the competitive landscape. Thus, these companies turned into tech behemoths. Tencent's WeChat, for example, has grown from 50 million users in 2012 to 1.3 billion users in 2023, and the reason their growth is now slowing is because almost every single smartphone user in China has the app.

It's not like these businesses are struggling. If we fire up Seeking Alpha, we can see that in the last 12 months, Tencent made 26 billion in operating income, Alibaba made 18 billion, JD made 4.2 billion, and Bilibili made 3 billion. These businesses are highly profitable. So why have they been beaten down so much?

Well, in the same way the Chinese political system helped these companies grow, it also causes some risks. The primary risk to investors is that the CCP can and will do what they want with these companies, which might come at the expense of investors. For example, in April 2021, the State Administration for Market Regulation of China imposed a record fine of 18.2 billion yuan (approximately $2.8 billion at the time) on Alibaba. This fine was the result of an antitrust investigation that concluded the company had abused its market dominance.

Later on in that year, Alibaba also mysteriously announced that it would make a 15.5 billion dollar donation to the Common Prosperity Fund to help fund the Chinese government's focus on technological innovation, rural development, and more across 10 initiatives. Similarly, in 2021, Tencent also made two whopping donations in a similar manner—the first being $7.7 billion and later an additional $15 billion.

Now apparently those donations were completely of the company's own accord, but I think investors would have preferred that money maybe as a dividend before it was sent off as a donation. Another risk investors have been wary of is the structure of ownership in these businesses. For example, while Alibaba is a Chinese company, as a foreigner, you can't buy shares in that company; they're the rules.

So instead, Alibaba sets up an offshore holding company called Alibaba Group Holding Limited that's incorporated in the Cayman Islands, which has an agreement with Alibaba's operating businesses in China that states the offshore company is entitled to the company's profits. Then what happens is U.S. investors buy into this variable interest entity in the Cayman Islands through American Depository Receipts.

Now, while that's all above board, many investors are wary that if the CCP wanted to crack down on the VIE structure, they probably could, which could spell trouble for foreign investors. There's even concern on home soil that if geopolitical tensions rise further, the U.S. might kick some of these U.S. listed Chinese businesses off of U.S. exchanges—a blow that would most annoy the CCP but would hurt the Chinese tech stocks even more.

And then finally, the last really notable risk stems from the Chinese economy itself. Because the CCP has total control over Chinese economic conditions, that means the ability for Chinese businesses to flourish in part is controlled by the Chinese government. For example, thanks to the CCP's crackdown on real estate developers and their decision not to do wide scale stimulus coming out of the COVID lockdowns, it's left the Chinese consumer grappling with falling wealth, as so much of Chinese wealth is tied up in home prices. Ultimately, it means that Chinese consumers are not spending. A pullback in spending hampers business profits in China, which ultimately impacts the values of these large Chinese companies.

It's a really controversial holding because of the various opinions about China versus America, etc. Even the VIEs and ADRs are all under question, and a lot of this uncertainty officially puts the price down. So these risks around the Chinese government and rising geopolitical tensions between the United States and China really are causing the share prices of the Chinese tech stocks to suffer in the current environment. The uncertain keeps investors away, which keeps the share prices depressed. But for some, that is seen as an opportunity.

Now, I want to be clear in this video that I do not mean to imply a buy, hold, or sell recommendation on any of these stocks. Any advice given is general in nature, and it might not be right for you. But there is no denying that many value investors are seeing the depressed share prices on these really strong Chinese tech companies, and they are seeing that as an opportunity.

I recently spoke to Matthew Peterson of Peterson Capital Management about this to get an understanding of exactly why many value investors are so interested in this current situation. Why is it that the late Charlie Munger, Monish Pabrai, Guy Spier, Howard Marks, Michael Burry, and so on are all willing to take on the risks I spoke about previously and are pursuing the Chinese tech stocks as an investment opportunity?

Matt used one of the stocks he holds in his portfolio, Alibaba, as an example. Alibaba, over the next 10 or 20 years, will maintain its dominance as one of these key players in the large tech space. Alibaba, in my perspective, is one of the cheapest large companies that exists in the world, and that's really what it comes down to.

The political risks involved have created a rare situation where these exceptionally strong businesses are now at very depressed valuations. While there are some risks involved, like everything in investing, it's how you view that risk to reward scenario. For these big value investors, maybe they don't go all-in, but they do still see the risk as worth taking to acquire a piece of some of these strong businesses at what they see as bargain prices.

It's shocking to a value investor how a company that earns $200 billion, has cost $200 billion, and has $50 billion in cash is buying back all their shares and earning $25 billion a year in EBITDA. In like six years from now, they'll have earned the whole enterprise value of the business getting cash.

I want to take you guys through exactly what Matt was just explaining. The enterprise value of a stock is simply the value of a business or the market capitalization after you pay back the debts and then you subtract the remaining cash off the market cap. Now in the case of Alibaba, we can see that on Seeking Alpha, they already give us this number. As you can see, while the market cap is $104.8 billion, the enterprise value is lower than that at $82.3 billion.

When you look at their EBITDA of $24.2 billion, as Matt said, their free cash flow—which is what I prefer to look at—of roughly $20.37 billion gives you an enterprise value to free cash flow multiple of 8.93, which essentially means the business will generate enough cash to pay the business owners back completely in around nine years. Then anything beyond that is a bonus.

If you look at the enterprise value to EBITDA, which were two of the numbers Matt quoted, as you can see, that multiple is even lower at 7.49—a level which unsurprisingly Seeking Alpha's rating system picks up as an A. So that's what the value investors are seeing, and for many of them, the risk-reward ratio is favorable.

We look at Alibaba and see all of this cash gushing into the firm and then them taking the capital and allocating it so strategically. They're buying back huge amounts of their stock. We can just buy so much more. There are certain risks, and we're aware of the risks—the VIE structures and all these kinds of things we watch them carefully.

But you have to go where there's like blood in the streets to find these great opportunities. It's not comfortable—generally, it's not very comfortable to be a value investor if you don't really understand what's happening under the business. It's that idea that you're going to get so much more value from these Chinese tech giants versus, say, the U.S. tech stocks—that's the very enticing part of the whole equation.

Matt focused in on Alibaba, as that's one that he's done his digging on, but the same applies across almost all of these companies. If we focus on just the ones held by the super investors, we can see similar trends. JD.com, for example, like Alibaba, is another e-commerce platform over in China. Their enterprise value is $32.85 billion, and they produced $4.9 billion in free cash flow across the past year. That's an enterprise value to free cash flow multiple of just 6.7, meaning the business owners will make back its value in just 6.7 years.

What about a slightly different business in Bilibili? Enterprise value of $23.15 billion, free cash flow of $4 billion, a ratio of 5.8—it's all a similar story. They're cheap, and the businesses themselves know that they're cheap.

As Matt mentioned earlier, Alibaba is currently buying back a lot of their shares. In the past 12 months, they've spent $18 billion on share repurchases. Tencent has repurchased $1 billion of stock in the last 12 months. Even Bilibili and JD have been doing some share buybacks to a lesser extent over the past few years, and generally, that's a pretty good sign for investors that the company believes that they're undervalued.

So this is a really interesting case study, and the reason it's so controversial is that investors fall on both sides of the fence. While there are some notable investors that hold shares in the Chinese tech companies, there are also a lot of value investors that have decided to steer clear because of those political and geopolitical risks. Warren Buffett is the classic example—Charlie Munger pulled the trigger; Buffett didn't want to.

It's a super interesting case study because it's pretty unanimous among the investing community that these businesses are cheap. It's just whether or not you as an investor believe it's worth the risk.

With that said, I once again wanted to thank Seeking Alpha for sponsoring this video. As you can tell, Seeking Alpha premium is a pretty darn handy resource to have in your arsenal as a value investor. I've been using it for years, and if you wanted to try it for free for 7 days, remember to sign up using my link in the description and pin comment.

If you do want to sign up, you also get a $25 discount, plus the price of Seeking Alpha premium will increase to $299 on October 1st. So if you use my link, you can lock in that lower rate before the hike.

But apart from that, definitely let me know what you think down in the comments section below. Are you interested in the Chinese tech stocks, or are the risks too high for you to get involved? Let me know your take down below. But apart from that, thanks very much for watching, guys, and I'll see you all in the next video.

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