When Charlie Munger (Trades, Portfolio)'s Daily Journal (DJCO, Financial) revealed that it had bought a position in Chinese e-commerce company Alibaba (BABA, Financial), I will admit that I was surprised.
In my research, I had developed the view that Munger likes to buy stocks with predictable long-term outlooks and substantial competitive advantages. Alibaba has both of these qualities to a certain extent. The company is the largest e-commerce retailer in China, which gives it a relatively predictable outlook, but its position in the market is not iron-clad. It is facing growing competition from the likes of JD.com (JD, Financial) and Pinduoduo (PDD, Financial).
At the same time, the company's competitive advantages are being eroded by these firms. Its advantage used to be that it was the biggest and the strongest e-tailer in the market. With money flooding into the Chinese e-commerce space, this advantage seems to be eroding by the day as competitors begin to catch up in terms of size (though they are still not near Alibaba's level quite yet).
One factor that provides more insight into the kind of business environment Alibaba is dealing with is the company's decision to start returning cash to investors with share repurchases.
Amazon comparison
Some investors and analysts have compared Alibaba to Amazon (AMZN, Financial) in its early days. They argue that its growth potential is only just getting started, much like the broader Chinese economy. As the country's economy expands, analysts claim the rising tide will lift all boats.
The thing is, since its inception, Amazon has consistently spent as much money as it can afford to develop its infrastructure and acquire customers. One might expect this from a company looking to allocate capital sensibly. Under any capital allocation framework, business reinvestment comes first, followed by debt reduction, and lastly, shareholder returns.
Alibaba has about $69 billion worth of cash compared to about $20 billion in debt, and at the beginning of August, it upped its share repurchase program to $15 billion from $10 billion through 2022.
The company can afford to repurchase shares, but in my opinion, it would be better to put this capital to use to build its market share and develop new businesses, especially when competitors are aggressively fighting for market share themselves.
Going back to the Amazon example, at the end of September, Amazon reported a cash balance of $79 billion with total debts of $67 billion, giving a net debt position of $12 billion, down from $17 billion at the end of 2020. As demand for the company's services has exploded, the corporation has been ramping up capital spending to capitalize on this demand. It has spent a total of $42 billion this year on capital projects, compared to just $24 billion of operating cash flow.
On the other hand, Alibaba's capital spending for the nine months to the end of 2021 was 29 billion Chinese yuan ($4.55 billion) compared to ¥69 billion of operating cash flow.
Managed decline
These are not the sort of numbers I would expect to see from a business aiming to grow aggressively. In fact, the situation sort of reminds me of the state of International Business Machines (IBM, Financial) in 2014. The company was skimping on capital investment, favoring shareholder returns through repurchases instead.
At a time when the corporation should have been investing billions to build out its cloud computing division to deal with the threat posed by Microsoft (MSFT, Financial) and Amazon, management was too busy trying to prop up the share price. The group entered a sort of managed decline.
I'm not saying I think Munger has made a mistake with this position, or that the company is destined for failure. I simply don't understand the appeal of Alibaba as an investment myself. I do not think the company is investing enough to maintain its market share in the hypercompetitive Chinese e-commerce market. This could significantly impact its growth over the next 10 years or so.
