BABA's free cash flow isn't free
Alibaba's free cash flow has been pumped up by stock based comp forever
Alibaba (BABA) plummeted back to $78 yesterday after announcing it no longer would be spinning off its cloud business (due to “uncertainties” over US chip export restrictions). On the surface this seems like a buying opportunity, market value is roughly $200B, minus a net $85B in cash/equivalents giving an enterprise value of only $115B. At a free cash flow of $24B (for year ending March 2023), thats a nearly insane 20%+ yield, meaning it trades slightly below 5 times FCF. But BABA’s problem is that all of that free cash flow isn’t free.
In 2023 Alibaba only reported $10.5B in net income, less than half of reported free cash flow. And TTM earnings are $12B, so still cheap with EV at just under 10 times earnings, but not so spectacular. So what should we use as the best proxy for BABA owner earnings, EPS or FCF/share? First let’s dig into why they differ so much. For most businesses it’s not unusual for FCF to differ significantly from reported earnings for a few years just because of payment timing or depreciation schedule differences from capex spending. But looking into Alibaba’s financial history, that’s not what is happening here.
From 2006 to 2023 Alibaba reported $116B in earnings, but $156B in free cash flow, creating an extra $40B in free cash flow in excess of earnings. $5B (12%) of the difference came from actual capital expenditures being less than depreciation and amortization. That’s not the smoking gun, as it’s not significant or unusual.
Instead the big addition to free cash flow from reported earnings was stock based compensation (SBC), which accounted for $37B or 93% of the difference. This is employee stock options, grants, restricted stock units, etc. Every time employees vest stock awards the estimated value (typically estimated from Black & Scholes) is expensed in the earnings calculation, since without the stock awards the employee would need to be paid a similar amount in cash comp. But since the SBC doesn’t cost the company a cash payment, it gets added back when calculating FCF.
But just because companies don’t write checks for SBC doesn’t mean they don’t have a cost, and it’s in dilution. The problem is it can be hard to see. Since 2022 Alibaba’s ADR share count has actually dropped 182M shares but only because it spent $25B buying back shares, more than offsetting issuing $10B worth of new shares as SBC during same period.
SBC is why we should use EPS over FCF as our proxy for Alibaba owner earnings. Its a large impact and EPS incorporates it, while FCF doesn’t. Again Alibaba still looks relatively cheap, whether it’s a bargain at these prices or not I’ll leave to you to decide.