What Has Charlie Munger Missed?

The legendary value investor missed a few major issues faced by Alibaba

By Grahamites

Summary

• Munger’s investment in Alibaba has priced in a management discount.
• Munger misjudged Alibaba’s competitive position.
• Munger underestimated Chinese government’s crackdown on Alibaba.

In my previous article Alibaba:A Sinking Ship, I laid out my view of Alibaba’s current and potentially structural long-term issues. As I mentioned, I have followed Alibaba Group Holding (BABA) since its IPO in 2014 and witnessed its glory days as well as its decline. When my investing idol Charlie Munger (Trades, Portfolio) took a stake in Alibaba in Q1 of 2021, I was very surprised. Since then Munger has admitted that investing in Alibaba was one of the biggest mistakes he has ever made. In this article, I’ll discuss what Charlie Munger (Trades, Portfolio) missed on Alibaba, based on my observations.

First of all, I think Charlie Munger (Trades, Portfolio) knew about Alibaba’s bureaucratic culture and Jack Ma’s legacy negative influence. He criticized Jack Ma’s idiotic behavior in a CNBC interview he did together with Warren Buffett (Trades, Portfolio). His exact words were:

“Jack Ma is one of the swingers. He basically gave a speech when he said to a, to a one-party state, ‘Well, you guys are a bunch of jerks, don’t know what you’re doing. And I know what I’m doing, and I’m gonna do it better.’ And he was gonna wade into banking and no rules and just do whatever he pleased. You don’t want a swinger to run. The banks have the implicit guarantee of the government, and you don’t, you don’t want to let any swinger run a bank. “

Later during the 2023 DJCO shareholder meeting, Munger said:

“Jack Ma got way out of line by popping off the way he did to the Chinese government. Of course, it hurt Alibaba.”

Therefore, clearly Munger’s investment decision has priced in a management discount.

The other mistake Munger admitted is that he was wrong in judge Alibaba’s business model, during the 2023 DJCO meeting, Munger said:

“In thinking about Alibaba, I got charmed by their position in the Chinese internet and didn’t stop to realize, ‘they’re still a god-damn retailer.’”

I think Munger’s mistake here is more than not realizing Alibaba’s still a retailer. His mistake is not having the daily user experience of Taobao, T-Mall and their competitors. To his credit, I knew Munger ordered some items from Alibaba’s competitor PDD Holdings
PDD
(PDD) and was amazed by the low price. But Munger probably didn’t fully understand PDD’s different business model and structural cost advantages against Alibaba.

Not on the ground in China is Munger’s disadvantage, because if you live in China, it’s very noticeable that consumers have been switching from Taobao to Pinduoduo over the past few years. It’s also very obvious that Douyin (Chinese version of TikTok) and to some extent, Kuaishou has also taken Taobao’s market share.

Therefore, while Munger admitted that Alibaba’s still a god-damn retailer, it looks like he didn’t do enough research on Taobao and T-Mall’s competitive environment. This is his biggest mistake.

Thirdly, Munger probably underestimated the influence of Chinese government on Chinese internet platform companies. Over the past few years, Alibaba has many negative social media coverage, some of the negative coverage is from government media. It is clear that the Chinese government targeted Alibaba in all major business units. On April 10^th of 2021, Chinese government fined Alibaba for a record of 18 billion yuan ($2.75 billion), after an anti-monopoly probe found that Alibaba had abused its dominant market position for several years. A month later, Ant Group’s planned $37 billion IPO was cancelled. It was a huge blow to Alibaba’s management and employees because Ant’s IPO was set to be the world’s biggest ever.

Chinese government’s crackdown on Alibaba went beyond the e-commerce and payment business, it also extended to Alibaba’s cloud business, which was once viewed by investors as Alibaba’s next big thing, like Amazon’s
AMZN
AWS business. However, due to Alibaba’s own mistakes and the Chinese government’s concern on data security, government entities and SOEs have mostly shifted to government-controlled cloud service providers such as China Mobile and China Telecom. In a deteriorating cloud market for private cloud service providers, Alibaba, Huawei and Tencent also engaged in a price war, which hurt all of them.

While Munger knew about Chinese’s government’s crackdown on internet companies, he probably was too optimistic on the outcome of the crackdown.

Combining Alibaba’s declining competitive moat, a cultural crisis, a dysfunctional management team, and the government crackdown, we get a powerful “lollapalooza effect” working against Alibaba. I don’t know if Munger realized this powerful lollapalooza effect, but if he did, he probably shouldn’t use leverage to add to Alibaba’s position.

To be fair, Alibaba’s valuation does look cheap. In fact, the most common argument for investing in Alibaba is its low valuation and the massive share buyback program. But the question is, how do you value a declining business? In the past, declining businesses provide a fertile ground for value traps. It’s not that easy to tell at this price, whether Alibaba is a value trap or not.

Conclusion

I have enormous respect for Charlie Munger (Trades, Portfolio). It is both encouraging and saddening to witness his mistake in investing in Alibaba. It is encouraging because it shows that no matter how great you are as a value investor, you still make mistakes. As a young value investor, I can cut myself some slack on my investment mistakes. It is saddening at the same time because I think Munger’s mistake is absolutely avoidable. He relied on his big picture judgment and clearly didn’t do enough research on the business. But at 99 years old, Munger can also cut himself some slack on this mistake. In the end, I want to wish Munger’s Alibaba investment to turn out fine. Time will tell.