More than halfway through its third calendar year as a public company, Alibaba Group Holding Ltd (NYSE:BABA) is on fire. BABA stock is up 74.6% year to date through August 4, considerably better than the 21.8% decrease in 2015 and an 8.1% gain last year.
The shares have pulled back some 4% from its all-time high late touched on July 27. InvestorPlace’s Brett Kenwell believes now is not the time to abandon Alibaba stock despite its impressive gains so far in 2017.
“Alibaba stock is now working with a huge tailwind,” wrote Kenwell July 28. “Although its business is not quite the same as Amazon, the two are riding the same wave. E-commerce is driving mega growth across multiple segments.”
It’s no coincidence that of the 27 stocks trading on U.S. stock exchanges, BABA and Amazon.com, Inc. (NASDAQ:AMZN) are two of the three best-performing stocks year to date.
Jack Ma and Jeff Bezos are both brilliant visionaries who see things us mere mortals can’t. Like Wayne Gretzky in his prime, they’re two steps ahead of everyone else.
As I see it, there are three things Alibaba needs do in the next 12 months if it wants BABA stock to maintain its momentum.
Generate More Revenue Outside China
China is a great domestic market. There would be nothing wrong if Jack Ma focused all of his attention there and never stepped outside its borders; Nothing at all.
However, that’s not what investors expect, and frankly, it’s not what Ma and the rest of the Alibaba team want. It seeks to dominate the world in many different categories including online retail, bricks-and-mortar retail, cloud computing, digital media and entertainment, and financial services.
The quickest way to grow each of these areas outside China is by acquisition.
Alibaba finished fiscal 2017 with $14.7 billion in net cash and $5.0 billion in free cash flow, so it’s got plenty of dry powder and it’s growing with each successive quarter. In the past five years, Alibaba’s grown free cash flow by 55% compounded annually; that’s doubling every 16 months. Add in the money coming off of the acquired companies, and you’ve got a cash flow machine.
Make One Particular Acquisition
While there are countless cloud-related businesses that I could list as acquisition targets, Mercadolibre is a natural because their e-commerce businesses are asset-light operations that act as the middleman between the buyers and sellers of merchandise.
While that’s beginning to change given its many forays into bricks-and-mortar retail, it still generates about 85% of its annual revenue from its core commerce segment, much of it online.
Mercadolibre generated $181.1 million operating income in fiscal 2016 from $844.4 million in revenue. With a current enterprise value of $12.5 billion or 48 times EBITDA, the valuation would make it a costly acquisition for Alibaba, but one that would get it further into the Americas. Which takes us to the next needed action.
Stop the Repurchases
In May, Alibaba announced that it had initiated a two-year buyback program to repurchase up to $6 billion of BABA stock. In fiscal 2017, the company bought back $1.9 billion of its shares in everyday purchases and another $2 billion from SoftBank Group Corp (OTCMKTS:SFTBF) which owns 29% of the company.
While I understand the repurchases from SoftBank, given how far Alibaba’s stock price has come in the past year, I also believe a better use of that cash is to invest in its business while also using the shares as currency for acquisitions.
Warren Buffett isn’t a fan of using stock to pay for acquisitions, but if used correctly in conjunction with repurchases when the share price is weaker, it can deliver a higher return on invested capital.
Bottom Line on BABA Stock
Both Amazon and BABA are stocks you want to own in both good times and bad.
The Chinese aspect of BABA worries many, and rightfully so given it’s still a bit of a Wild West show there when it comes to the rights of foreign investors in the country. However, I believe these issues will get sorted over time.
In the meantime, the future for Alibaba on a global basis continues to look good.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.