Thread by @GlennLuk

I had two major issues with this statement (

https://twitter.com/WallStCynic/status/1128643285185114117

). Thread on $BABA and a better way to break down its financials.

1/ The first + more obvious one is that annualizing Q1 makes no sense. Historically $BABA Q1 EBIT has accounted for between 11-16% of calendar year total. This is b/c of all the promotional activity in Q4 (Singles Day, etc.). You can't simply multiply it by 4 to get the run rate.

2/ The second is less obvious + has to do with the balance sheet. Dividing consolidated EBIT by the consolidated book equity amount (i.e. RoIC) generates a meaningless figure. To get a meaningful number, you need to break $BABA into three buckets.

3/ These would be:

(a) the mature, profitable commerce businesses (mostly Taobao/Tmall)
(b) the growth-oriented consolidated businesses (e.g. Freshippo, Cloud etc.)
(c) the investment portfolio, a mix of public and private investments and cash

See attached.

4/ >100% of $BABA EBIT + cashflow comes from (a), its mature commerce businesses. A portion of these cashflows are used to fund the other loss-making consolidated businesses. The rest mostly go towards acquisitions or new investments.

5/ As for the investment portfolio, it does not contribute to EBIT, even if they are quality investments. This is just the way the accounting works.

6/ Meanwhile, book equity (i.e. in the denominator of RoIC) is almost entirely derived from a) the carrying value of the investment portfolio + cash b) goodwill generated from the acquisitions.

7/ The goodwill is mostly related to the aforementioned loss-making consolidated entities. These businesses are typically not capital-intensive by nature, and their goodwill-inflated balance sheet figure is again merely a function of accounting rules.

8/ If you strip out PP&E, the majority of which is related to servers and datacenter eq. in the Alibaba Cloud business, you will find that Taobao/TMall generate all of that profit with attributable book equity that is effective negative.

9/ This is one of the attractive features of the Taobao/Tmall business model - sitting in the middle of transactions b/n consumers & merchants, which leads to a rising current liability account (merchant deposits, etc.). It's roughly analogous to insurance float.

10/ IOW far from being a business that is "scaling negatively", instead of consuming capital, it actually generates CF as it grows. Technically, it is an infinite return on capital business. That plus 70%+ operating margins makes for a pretty darn attractive business model.

11/ Of course the other implication is that the other loss-making consolidated businesses are generating negative returns on large book equity (albeit comprised mostly of goodwill). But this is true of most acquired tech companies and ventures today.

12/ Whether these businesses represent smart capital allocation decisions ultimately depends on individual merit, not on current RoIC metrics. For most, it is still too early too tell. You need to evaluate each individually vs. lumping them together in a consolidated blob.

13/ Similarly, the investment portfolio needs to be evaluated on an investment-by-investment basis. This is not always so easy, given the limited amount of exposure especially on the smaller deals.

14/ The publicly listed ones are fairly easy to put some sense of market value, the private ones less easy. The good news is that the portfolio is dominated by a handful of large ones, most notably Ant Financial.

15/ In summary, $BABA is not the easiest business to understand but it can be done if you spend the time, learn some accounting and break it down into its component parts. /END