Thursday, August 24, 2017

Something Fishy......

I was on a fishing charter in the middle of Lake Erie while Alibaba Management was conducting their always entertaining, quarterly earnings call last week.  After listening to the archived Recording and scanning through the 6-K, Presentation and Press Release (links below) , based on the ridiculous content, I have to say.....I'm glad I went fishing.



Rather than rehash the details, most of the nitty-gritty of Alibaba's financial prestidigitation is discussed in my June 23rd, 20-F analysis.  If I were to describe the most recent earnings release in one sentence, I'd say that Jack, Joe, Maggie, Daniel and company have chosen to double down on their (alleged) "pants-on-fire" misrepresentations.  The whole thing is getting more preposterous by the quarter.

Here are a few of the less-than-believable metrics we've been discussing since the IPO:

1.) Fake Revenue: Incredible 56% revenue growth last quarter.  If we do a little math (based on ratios described in the 20-F just a couple of months ago) we can extrapolate that, according to their numbers, Alibaba now sells nearly all of the On-Line, Retail, Consumer Physical Goods in China. When we compare Alibaba's GMV figures to China's National Bureau of Statistics (The Chinese counterpart of the US Bureau of Economic Analysis), Alibaba handled roughly US$176 Billion of GMV, or 92% of all of China's On-line Retail Consumer Physical Goods, in its "ecosystem" in the quarter. The most astounding aspect of this odd math, is that the NBS reports that On-Line sales in the quarter grew at "only" 28.6% (Clothing, Alibaba's presumed meal ticket was only 20.8%).  Alibaba's reported 56% Revenue Growth would seem implausible (since they are effectively the entire On-Line Economy in China now...) unless they have somehow nearly doubled the revenue associated with each On-Line transaction in the last couple of months since the 20-F......which would also seem to contradict the law of large numbers.

NBS - June Quarter - In the first six months of 2017, the national online retail sales of goods and services was 3,107.3 billion yuan, increased 33.4 percent year-on-year. Of which, the online retail sales of physical goods was 2374.7 billion yuan, increased 28.6 percent, accounting for 13.8 percent of the total retail sales of consumer goods; Of the online retail sales of physical goods, food, clothing and other commodities went up by 25.1 percent, 20.8 percent and 31.8 percent respectively.

How can they accomplish this magic?  Remember, from the SEC Correspondence file, Alibaba's GMV sales do not actually have to be closed on the platform......they just need to be somehow "reported as closed". This accounting magic explains the plethora of luxury knock-offs (Gucci, Prada, Coach, Ralph Lauren, Rolex, Cartier, etc.), yachts, vehicles, industrial goods (pipe, steel, fuel oil, etc.)  bad loans, real estate, commercial paper, etc. all available for purchase in the Alibaba "ecosystem". Go ahead, search for some of these things on Taobao and TMall....it's a hoot. Needless to say, shoppers don't actually plunk down their Alipay card to purchase yachts and foreclosed buildings on-line, but Alibaba management apparently has the world convinced that they do. They want us to believe that the lion's share of GMV is comprised of FMCG (Fast Moving Consumer Goods) when in reality GMV is now mostly SMFG (Slow Moving Fake Goods).

2.) "Questionable Assets": (Investment Securities, Goodwill, Intangibles, Land Use Rights and Investments in "Investees") are now a whopping US$44 Billion (56% of the balance sheet) ....compared to roughly US$0.00 (0.00%) prior to the IPO just four short years ago.  When we compare this figure to Amazon (4.8% of the Balance Sheet), Tesla (3.8% of the Balance Sheet) or even E-Bay (34% of the Balance Sheet) we can only conclude that Alibaba Management is creating financial vapor at an unprecedented pace.

3.) "Questionable Assets" - Valuation: We already know that roughly US$3.5 Billion (more than half of last fiscal year's earnings) of these assets; Alibaba Pictures (US$2.1 Billion) and Alibaba Health (US$1.4 Billion); should be immediately written off if Alibaba Management were actually following GAAP and marking-to-market as described in my last post, Finding Inner Peace in Dharamsala .....and thoughts on the Alibaba 20-F....   Based on these "in your face" accounting shenanigans alone, it would be difficult to believe that the remaining US$40 Billion isn't significantly goosed as well.  Since none of these "Investees" seem to be generating actual earnings, the probability that these carrying values reflect economic reality is approaching zero.

4.) No New Customers: Annual Active Consumers (AAC) increased to 466 million, a 3% increase QoQ and a 7% increase YoY.  When we compare this slower (more believable) AAC growth to the massive (less believable) revenue growth (56% YoY) we wonder how is this even remotely possible?  Did the same customers suddenly all decide to purchase 1.5x what they had been doing last year?  Again, the law of large numbers tells us that AAC growth simply doesn't track with revenue and extrapolated GMV.

5.) No Turn Around : We continue to see that Koubei, Cainiao and the other "Investees" continue to lose US$200 Million a quarter, like clockwork (pg. 16 of the Press Release).

6.) More Overhead: Alibaba brought on an additional 7,205 employees in the quarter (Primarily related to the consolidation of InTime).

7.) Unbelievable Cost Cutting!: Even after adding all of these employees, and incurring all of the newly acquired overhead and losses, Costs & Expenses decreased from 75% of revenue in the March 2017 Quarter to 65% in the June Quarter.  (Pg. 12 of the Press Release)  A skeptic could conclude, because of the 660+ related companies in Alibaba ecosystem, that there's a good chance that not all of the company's distribution and transaction costs are accurately reflected in the income statement.

8.) Professional Standards:  Finally, in an, I'm sure, unrelated matter, PWC, Alibaba's auditor, seems to be setting new records for regulatory fines every couple of months.  They were fined US$6.6 Million (RSM Tenon Group Plc) a few weeks ago and US$6 Million (Connaught Plc audit) in May, 2017 for, generally, "falling short of professional standards".  Apparently, looking the other way when your crooked client tells you to do so, falls a tad short of meeting "professional standards". I'd imagine that this is just a horrible coincidence. I'm sure everything is just fine at Alibaba.

And the result of all of the above?

Mr. Market Loves Alibaba!






































The valuation is astounding. When we compare Alibaba's valuation metrics to other large, high-flying tech stocks, Alibaba is about as pricey as they get.





Alibaba sports a valuation of $19.90 of Market Cap for every dollar of Tangible Book Value (Book Value net of Goodwill and Intangibles).  The ratio is 2x to 4x the ratios of Apple, Alphabet or Tesla. The only business with a higher valuation based on this metric is Amazon at $27:1.


Moreover, Alibaba's P/E ratio is 59......the company is valued at just shy of 60 years of current (allegedly fake) earnings.  As I've mentioned above, if the nonsensical carrying values of the Questionable Assets were written off/down, the ratio would more likely approach Amazon/Tesla territory.

For your pleasure.......here are a couple of my other favorite stock charts.....








































Aren't those roller coasters amazing?  What a ride...... 

And more recently.........




























The funny thing is......like Alibaba, Mr. Market loved Enron, Worldcom and Valeant for quite a while too!


Additional References:

NBS 2014
In 2014, the national online retail sales was 2,789.8 billion yuan, (US$ 453.5B @ RMB 6.15= $1.00) increased 49.7 percent year-on-year. Of which, the online retail sales of units above designated size was 440.0 billion yuan, increased 56.2 percent.

YE March 31st, 2014 - US$394 Billion - 87% of China's on-line sales.


NBS - 1/17 thru 6/17 - Retail Sales of Physical Goods- RMB 2,374.7B
http://www.stats.gov.cn/english/PressRelease/201707/t20170718_1514101.html

NBS - 1/17 thru 3/17 - Retail Sales of Physical Goods- RMB 1,067.4B
http://www.stats.gov.cn/english/PressRelease/201704/t20170418_1485782.html


Webcast
https://edge.media-server.com/m6/p/mfe3o8kf

Press Release
http://www.alibabagroup.com/en/news/press_pdf/p170817.pdf

Presentation
http://www.alibabagroup.com/en/ir/presentations/pre170817.pdf

6-K
https://www.sec.gov/Archives/edgar/data/1577552/000110465917052468/a17-20562_1ex99d1.htm




14 comments:

  1. The hole I see is that Valeant, Enron, Worldcom and most major blowups all used copious amounts of debt.

    Alibaba's one of those new age companies that doesn't seem to need nearly as much capital to grow.

    As much as I think you're correct about the accounting aspects, the market seems to only care for continued growth of market share.

    How this all resolves itself still seems a mystery to me.

    Did you catch those perch? Good eating.

    ReplyDelete
  2. Agreed...the debt levels are a stark contrast.....at least on the surface. On the other hand, the convoluted corporate structure....660 consolidated entities (and rapidly growing) in the VIE would make it possible for the business to conceal all sorts of debts/guarantees/arrangements. "Mystery" is indeed the operative term.

    Yup....limited out in three hours...fish finding technology has come a long way.....big fish too.. ..delicious!

    ReplyDelete
    Replies
    1. I've found the whole China U.S. relationship to be quite pathetic looking back. The U.S. kind of stupidly follows this free market dogma where the Fed is supposed to solve our problems through control of the money supply. China's sole plan is stability, production and full employment. They can delay their financial issues and pass them on by intelligently stealing away market share through mercantilism and IP theft and tightly controlling their banking system and currency. The U.S. really has no industrial or economic policy whereas it's China's only focus.

      The status quo breaks if the U.S. just begins to be a little more intelligent in trade. My bewilderment is how this kept going for so long.

      I appreciate it every time you write about Alibaba. But I can't help but always be bothered by the fact that accounting, the rule of law, market economy dogma all mean nothing to China. They play their game in a completely different way. But their game relies heavily on foreign patsies.

      They won't change their policies until they change their politics or unless they are forced to change their policies through a change in the international environment.

      In a sense, China has the most stable set of economic policy in the world due to their unique history and governance. But the caveat is that their policies are destabilizing for the rest of the world.

      Betting against China isn't easy because the government almost facilitates financial stability. It's like they have super financial regulators who have all the power. But the contradiction is that they only need such regulators because their system is fundamentally designed to not be able to stand on its own. But it does very well when it's attached to a strong globalized world order.

      Not sure how it will all play out with respect to Alibaba, but I felt that the macro would be pretty relevant here.

      Delete
    2. Agreed.....one addition: stability by brute force is not necessarily stability...but it works until it doesn't...

      Look at the China's money supply v the exchange rate since 2010....the relationship is not possible....yet the condition exists...

      I'd refer you back to my "Theory of Financial Relativity" and "Cheap Reading Glasses and the Wiemar Republic" posts....we are on the same page....

      Best....

      DT

      Delete
  3. Agree on many points Deep Throat makes on BABA - GMV doubts, related party transactions etc.

    However, the key reason as to why the share price has taken off is due to the greater than expected growth in 'marketing services' i.e. bidding on keywords and display advertising.
    Wouldn't these marketing revenues be an easy thing to Audit?

    ReplyDelete
    Replies
    1. Interesting take.....I'd note, they changed the terminology from "marketing services" as was described in the 20-F to "customer management revenue" for this 6-K. (presumably going forward)

      Alibaba Management seems to routinely change the definitions of reporting metrics, classifications, etc.... for no apparent reason and without sufficient explanation:

      "The significant growth in customer management revenue represents the differentiated business value we provide to our customers,” said Maggie Wu, Chief Financial Officer of Alibaba Group.

      Based on the brand new definition (or the old for that matter), It would be difficult to determine whether it's easy to audit (or not) until I understood the source and composition of the "differentiated business value"......whatever that means....

      Delete
  4. Hi! First of all, congratulations on your blog, it is very interesting and thorough. Also, I just wanted to ask: do you have any other source where I can read your content or get notified about your new posts? I'm not really a blogspot user but I liked your content more than enough to ask you if maybe I can follow you on Facebook or Tumblr or even Twitter, since I can't figure out how to subscribe to your blogspot (I clicked to a link at the bottom but it only redirects me to a page full of xml text).. hope this is not too much to ask! If so, don't sweat it. Thanks a lot either way :)

    ReplyDelete
  5. Hmmmmmm....that's strange Alejandra......I have many followers. I'll check into this and let you know what I find. You are saying that the "Post Comments (Atom) link redirects you to an HTML text screen?

    ReplyDelete
  6. DT,
    your post on BABA is great. But the valuation table you referred us above (one of possible many ways to estimate "value") should make one more concerned about their Amazon position (the only true comparable business to Baba of all the ones listed ). Even with SEC investigation of alleged troublesome Earning/Revenue accounting and reporting (inconclusive so far!) it is AMZ at 240 years of existing earnings the more troublesome of the two.

    Capoy

    ReplyDelete
    Replies
    1. They are two distinct and separate cases: Amazon and Tesla are "overvalued" because of Mr. Market's optimism on the prospects of the business. The financials are most likely "real". Alibaba is "overvalued" because of starry-eyed, optimistic investors reliance on "fake" numbers and (alleged) fraudulent accounting. i.e.) Amazon/Tesla are not committing financial crimes, whereas, Alibaba may be..that's the difference.

      Delete
  7. https://www.wsj.com/articles/how-an-alibaba-spinoff-created-the-worlds-largest-money-market-fund-1505295000

    This has to be a Ponzi scheme, right?

    ReplyDelete
    Replies
    1. It is peculiar.....it might be a Ponzi....but it might not. The consistent returns, well above market rate is a red flag. The point is, because of the opaque accounting, questionable reported metrics and maze of interrelated accounting entities screaming conflict of interest, we will have no way of knowing until the tide goes out.....which could be a long time based solely on the AUM of the fund. As long as the Chinese people keep shoveling money into it, like any Ponzi, it won't be exposed.

      Delete
  8. hi DT
    i had a question for you on Alipay growth vs reported revenue growth. p189 of the 20F details what BABA paid Alipay for services rendered - search "Alipay Commercial Agreement". In FY2017 BABA paid Alipay RMB5487m which represented growth of just 12% - jarring with the 42% growth in China Commerce revenue growth. Sure, the rate BABA pay might have come down, but this much? Unfortunately these are only annual disclosures. Any thoughts?

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  9. I'm familiar.....yet another ratio that doesn't make sense.....most likely more earnings management. Sorry for the delayed response/post.....traveling right now in rural India & have been a bit "off the grid"....hope all is well.

    ReplyDelete