Last week, The Wall Street Journal reported that Ant Financial, the owner of China’s largest mobile payments platform and affiliate company of Alibaba, is preparing to raise $9 billion in a funding round at a rumoured valuation of up to $150 billion. This would make Ant Financial by far the most valuable privately-owned technology company in the world, at a valuation likely more than double that of Uber. This milestone also highlights an important lesson for investors – the gains that can be had by owning companies with free real options.
Ant Financial is conducting this fundraising round ahead of its highly anticipated IPO, likely to come as soon as later this year. One of the challenges for public equity investors is that by the time high growth companies such as Ant Financial make their public market debut, the truly outsized gains have already been reaped by the private venture capital investors. Fortunately for Montaka investors, the fund has owned Alibaba since inception in July 2015. We assessed Alibaba to be a very high-quality business at the centre of the Chinese digital consumer economy, available at a steep discount to just its core e-commerce and marketing business. The real kicker, though, was Alibaba’s portfolio of real options that we were getting for free, the crown jewel of which was Ant Financial. Alibaba presently receives a 37.5% profit share from Ant Financial, but that is expected to be replaced by a 33% equity interest prior to the IPO.
Some readers might argue that such options are rarely enough to move the needle for large companies – true, a potential $50 billion equity interest in Ant Financial is barely 10% of Alibaba’s $450 billion market capitalisation. However, we received this option for free when we bought Alibaba’s core business, and investors should take any free upside they can get. By buying a core business at a discount to our estimate of intrinsic value, we effectively de-risk any attached options. Had Alibaba’s portfolio of real options turned out to be worthless, it is unlikely that our investment in Alibaba would have been materially impaired.
Other examples of free optionality include Alphabet and Apple. Alphabet owns Google plus a portfolio of “other bets” and “moonshots”. So long as investors are confident that they are getting the core Google advertising business at a fair price, they are effectively receiving the portfolio of other bets for free. While some options are ambitious with low probably of success, such as Google Fibre, other options such as Waymo have the potential to become global game-changers. Likewise, Apple has a stable core business of selling iPhones and other hardware, a rapidly-growing services business underpinned by the 1.3 billion active Apple devices globally, and is spending more than $1 billion a month on R&D. Part of that R&D will go towards upgrading and innovating on Apple’s existing hardware and software products, but another portion will undoubtedly go towards developing entirely new products. Put differently, Apple is spending several billion dollars a year on R&D but not presently receiving a return on that investment. Apple has been more secretive in this regard than its competitors, but some areas of focus include augmented reality, connected wearables and what has been dubbed Project Titan.
One other thing readers may have noticed about the above examples and other companies with free optionality is that they tend to be large (and often online) technology platforms. These options tend to be more valuable within large platform businesses due to their size, which can be leveraged to quickly scale up new projects. Ant Financial began as the payments platform for Alibaba, Amazon Web Services and Fulfillment By Amazon were initially internal services for Amazon’s e-commerce business, and Alphabet’s AI projects are underpinned by the search engine’s enormous dataset. We have previously written about why we like to invest in online technology platforms (here and here), and these portfolios of real options are often the (free) icing on the cake.
Montaka owns shares in BABA (NYSE: BABA), Alphabet (Nasdaq: GOOGL) and Apple (Nasdaq: AAPL)