Michael Burry, the investor renowned for his prescient short position in the 2007 subprime mortgage crisis, has significantly increased his stake in Alibaba (NYSE:BABA), according to recent 13F filings by his firm Scion Asset Management. Burry has boosted his holding of BABA shares by 24%, simultaneously reducing his positions in other companies. This move has made Alibaba the largest holding in his portfolio, accounting for 21% of its total value. Combined with other significant Chinese stock investments in Baidu (BIDU) and JD.com (JD), Chinese equities now constitute roughly 45% of Scion's holdings.
This development suggests a bullish outlook for large-cap Chinese stocks, particularly Alibaba. Investment sentiment towards Chinese stocks remains deeply divided. Some investors remain highly sceptical, citing the Chinese Communist Party's (CCP) tight control over the country and concerns over deglobalization and geopolitical tensions. The ongoing standoff with Taiwan, and Xi Jinping's increasingly assertive leadership, add further complexity to the situation.
Conversely, others believe that these risks are overblown and that the current market pessimism has driven valuations of Chinese companies to attractive levels. They highlight Alibaba's strong fundamentals, including its significant cash position and share buyback programme, as reasons for optimism.
While acknowledging the inherent risks associated with Chinese equities, it is worth considering the possibility of a contrarian opportunity. Both Alibaba and the Chinese large-cap index, FXI, have suffered considerable market downturns in recent years. Despite its profitability, BABA trades at attractive valuations, with an overall A+ profitability grade on Seeking Alpha and scoring well on key metrics like PEG, PE, EV/EBITDA, and PB ratios.
Alibaba's share buyback programme, which has seen the company retire 5% of its shares in fiscal year 2024, presents a significant potential for shareholder value creation. This is further enhanced by the company's dividend payout, initiated in 2024, which carries a safe payout ratio of 11.7%. Alibaba's strong cash position, exceeding $12.68 per share, coupled with free cash flow of $7 per share and earnings per share of $3.86, bolsters the sustainability of these initiatives.
The CCP's influence, however, remains a significant headwind. A potential invasion of Taiwan could trigger the delisting of Chinese stocks from Western markets, mirroring the fate of Russian equities in 2022. This scenario would lead to a complete loss of value for BABA shareholders holding American Depositary Receipts (ADRs), despite the continued trading of Alibaba shares on the Hong Kong Stock Exchange.
The CCP's influence extends beyond geopolitical tensions. The Chinese economy faces its own set of challenges, and the CCP's lack of transparency makes it difficult to assess the true state of affairs. The collapse of Evergrande, a prominent example of the CCP's policies backfiring, highlights the potential for economic instability. Furthermore, a surge in demand for physical gold by Chinese citizens reflects a growing sense of economic uncertainty, potentially creating a self-fulfilling prophecy.
Alibaba's reliance on the Chinese consumer market exposes it to further risks. A weakening Chinese economy could impact the company's revenue, particularly in the discretionary consumer goods sector. This could further erode sentiment, curtailing buyback programmes and undermining the bullish thesis surrounding the company's cash flow-driven growth.
A potential escalation in tensions over Taiwan, however, represents a far greater risk. A military intervention by China could trigger international sanctions, potentially pushing the country's economy into a deeper crisis. This scenario could also serve as a political tool for Xi Jinping, allowing him to divert public attention from domestic issues and advance his reunification agenda.
Given these inherent risks, a cautious approach is advised. Out-of-the-money (OTM) call options could provide a suitable investment vehicle. This strategy limits downside risk to the premium paid for the option, effectively acting as insurance against the realisation of the aforementioned tail risks. The current market pessimism surrounding Alibaba presents a potential contrarian opportunity, with the low upfront cost of OTM calls allowing investors to make highly asymmetric bets.
Alibaba's stock price has exhibited significant volatility in recent years, largely driven by shifts in investor sentiment. If the buyback programme succeeds in driving up the price, a change in sentiment could trigger a rally towards $120 per share, representing a 50% increase from current levels. Buying a September 2025 BABA call option with a strike price of $120 for a premium of $320 could offer substantial upside potential.
Interestingly, BABA call options with higher strike prices are priced with lower implied volatilities, hinting at depressed market sentiment. Any positive revaluation of the company's prospects could lead to a significant increase in the value of OTM calls, driven by a reassessment of implied volatility.
It's important to note that the time decay of OTM options is a real factor. Every day that BABA remains at current levels will erode the principal investment. This trade represents a high-risk, high-reward strategy that aims to limit downside exposure while acknowledging the potential for significant upside in the face of market uncertainty.
