Event: Alibaba (BABA) reports Q4 results tomorrow before the open. The options market is implying about a 7% one day move, which is rich to the stock’s 5.75% average one day move over its 6 quarters as a publicly traded company.
Price Action / Techncials: BABA is down 13% in 2016, down 30% from its 52 week highs made one year ago, and up 25% from its 52 week and all time lows made in late September.
Since the stock’s initial post IPO gains of almost 100%, the stock has been a train-wreck, losing at one point 50% of its value this past September, and now down about 40%. The October breakout above the downtrend, and its consolidation above $80 was encouraging merely from a technical standpoint. But then the calendar turned to 2016. A continued failure at the downtrend would very likely mean a re-test of the prior lows in the coming months:
Expectations for the Quarter:
Mark Mahaney, RBC’s internet analyst in a note to clients highlighted the following:
1) Margin Trends– We are looking for GM’s of 72% (+~100 bps Y/Y) and EBITDA Margin of 57% in the December Quarter (vs. 58% in Dec. ‘14);
2) China Retail Desktop & Mobile Trends– We are looking for China Retail Desktop segment GMV of 328B RMB and segment revenue of 10.3B RMB (3.13% Take Rate) for the December quarter. And we are looking for Mobile segment GMV of 638B RMB (+95% Y/Y) and segment revenue of 19.4B RMB (3.04% Take Rate) for the December quarter; &
3) Taobao & Tmall Marketplace Trends – We expect Taobao GMV of 579B RMB (+17%Y/Y) and Tmall GMV of 386B RMB (+32% Y/Y).
And Mark’s View on Valuation:
Our $95 price target is based on EV/EBITDA and P/E methodologies—and supported by a DCF analysis. Specifically, we apply a 15x multiple to our CY17E EBITDA of $14.1B and a 24x multiple to our CY17E Adjusted EPS of $4.09 to reach our $95 price target.
Options Volatility Snapshot: Short dated options prices are just coming off of all time highs, but still well above the levels from almost every earnings period since its 2014 ipo, with 30 day at the money implied volatility at 45%, which is enormous for a company of its size ($175 billion market cap).
The best trade on the board is likely short premium trades into the print.
My View into the Print: The Dec quarter should be fine as it included Singles Day, and the current quarter could be below expectations as a result of the impending Chinese New Year celebration between Feb 7th to 13th. Obviously Apple’s commentary last night about the Chinese economy, and Starbucks last week missing comps in the country for the second year in a row could hint to weaker guidance from a consumer behemoth like BABA, but it’s important to remember that the secular shift towards eCommerce in China could serve as a massive tailwind for BABA despite a weak domestic economy. The issue for BABA is profitability and spending. The company (like Amazon, their brother from another mother in the U.S.) has stated they are not managing their business on a quarter to quarter basis.
So What’s the Trade?
For those that are long we like two protective trades, one against stock, and one that replaces stock or is defined risk for those looking at it for a new long. The first is a put spread collar against long stock:
Against 100 shares of BABA (71) buy the March 65/57.5 put spread vs 80 call collar for .25
- Buy 1 March 65 put for 2.15
- Sell 1 March 57.5 put at .85
- Sell 1 March 80 call at 1.05
Rationale – Similar to the AAPL collar we detailed this is disaster protection but we’re able to get it closer to where the stock is trading by spreading the put portion. It’s unlikely that BABA gets higher than $80 where one would be called away, so gains above are similar to stock. But protection is in place below 65 and down to 57.50 which is the all time lows in the stock from September ’15 . It’s most likely scenario is that you lose .25 against your stock as chances are the stock is above 65 and below 80, but that would be money well spent to protect an investment because if it does retest its all time lows that .25 will have protected against 7.25 in losses in the stock.
The second trade idea is for those looking to be long BABA but with defined risk. This strategy works to either replace existing stock or for new longs that don’t want to have a ton of capital at risk in case of a swift decline on earnings.
In Lieu of 100 shares of BABA (70.50) buy the February 70/77.5/85 call butterfly for 2.25
- Buy 1 Feb 70 call for 3.65
- Sell 2 Feb 77.5 calls at .75 (1.50 total)
- Buy 1 Feb 85 call for .10
Rationale – This butterfly risks 2.25 and targets a move higher near the converging 50 and 200 day moving averages in the stock which seems like a realistic near term target on the upside. It differs from stock in that the most that can be lost is 2.25 on a big move lower, and that profits begin to trail off above 77.50 with a loss above 82.75. It’s break even is 72.25, which is above where the stock is currently trading so the stock going sideways isn’t great. But for those looking to define their risk on a long this is better than stock.