Summary of Key Points
Alibaba recently made two contrasting moves: first, it spent $162 million to repurchase 13.4 million shares (claiming it was a way to “reward shareholders”), and two months later, it issued 710 million new shares (53 times the amount of shares repurchased), raising approximately HK$8 billion to invest entirely in AI. As a result, the shareholding percentage of existing shareholders will be diluted (for example, from 1% to 0.964%). However, the company will receive the cash to fund its AI infrastructure and applications. The market reacted negatively, with Alibaba’s Hong Kong stock price falling by 10% and breaking below the issue price, reflecting investors’ concerns about share dilution and the potential returns from AI investments.
Detailed Analysis
1. What is a rights issue, and how does it lead to share dilution?
A rights issue is when a company issues new shares to new investors (such as institutions). Suppose the company originally had 100 shares (representing 100 “cakes”), and you owned 1 share (1%). Now the company produces 71 more shares, bringing the total to 107.1 shares, so your share becomes 0.934% of the total. Although the number of shares you hold remains the same, the value of your share in the company’s equity decreases. This decrease is due to the expansion of the “denominator” (the total number of shares).
2. With $474.5 billion in cash, why does Alibaba still need to issue rights shares?
Despite having $474.5 billion in cash, Alibaba is doing so because AI is a high-cost endeavor:
- The company’s cash decreased by $463 million in one quarter, and capital expenditures (such as purchasing servers and building data centers) increased by 75%, mainly for AI infrastructure.
- AI applications (like Qianwen) incurred a quarterly loss of $13.8 billion, $106 billion more than the same period last year. This is because users have to pay for the computational resources used by these applications, but the company has not yet found a profitable model.
- Issuing rights shares is a better option than borrowing money: there is no need to repay the principal or pay fixed interest, allowing the company to preserve its cash and debt profile and avoid future financial pressures.
3. Where will the $8 billion invested in AI go?
The announcement states that all the funds will be used for “full-stack AI,” but the specifics are not detailed:
- Hardware: purchasing chips (such as GPUs), building data centers, and servers.
- Software: training models (such as upgrading the Qianwen model).
- Applications: promoting and operating Qianwen (for example, by lowering usage barriers for users, although this may increase推理 costs).
However, the company has not specified over how many years the funds will be spent, how many chips will be purchased, or what revenue they will generate. It’s like saying “the money will be used for cooking,” but without specifying the amount of ingredients, the dishes to be made, or when the results will be available.
4. Why did the market decline?
The Alibaba stock price fell by 10% on August 24, breaking below the issue price of HK$112.7, due to two main reasons:
- Concerns about share dilution: Investors are worried that their earnings per share will be reduced, and they may not see immediate returns.
- The issue price seemed unfavorable: The issue price was HK$112.7, but the stock opened at HK$110.1, indicating that institutions purchasing the shares could potentially lose money. Additionally, the lack of information about the buyers added to investors’ uncertainty, as it wasn’t clear if sovereign funds were involved or if the underwriters would buy the shares if they didn’t find buyers.
5. What should ordinary shareholders do?
The key is to see whether AI investments will be profitable. There are no absolute advantages or disadvantages; the focus should be on whether the investment in AI will generate profits:
- Positive aspect: Alibaba’s cloud business is already profitable (AI-related cloud revenue increased by 45%, and adjusted profits grew by 133%). If AI applications become profitable in the future, the company’s size may increase, potentially leading to higher earnings per share.
- Negative aspect: If AI continues to be costly, the dilution effect will persist, meaning that any future profits will be shared among more shareholders.
In short, if the AI business succeeds in a few years, the 3.57% share dilution will be a minor issue. If not, shareholders will remember why the company decided to issue more shares.
Conclusion
Alibaba is taking a gamble by using share dilution to fund its AI future. If it succeeds, everyone will benefit from the company’s growth. If not, shareholders will end up with a smaller share of the company’s profits. We can only wait and see what the future holds.