Is Alibaba risking $2 billion to get $5 billion offshore?

May 28, 2024
Wherever you look on the web, there seems to be a lot of misunderstanding about the convertible, the conversion, the option calls, and what that all means for dilution. So let's try to clarify. Spoiler alert: you won't like what you'll read.
Two pieces of information are very important.
1. Alibaba is only buying 15 million shares now, and the rest later.
2. Alibaba bought $161 call options to avoid too much dilution.
There is no free money here for Alibaba.
The proceeds of the convertible are $5 billion, the conversion is around 9 shares per $1,000, or $105 per share. When that price is exceeded, Alibaba has to come up with 48 million shares ($5 billion divided by $105).
This conversion is fixed, meaning if the price goes up to $161, Alibaba still has to give the note holders 9 shares for their $1,000, which is a loss of $56 for every share it did not manage to buy below $105.
Now let me correct myself, they paid $500 million for the call options, so the net proceeds for Alibaba are $4.5 billion, and with that, it needs to buy all 48 million shares. The calculator shows that they need a price below $94 ($4.5 billion / 48 million) to be in the money. For every share it did not manage to buy below that price, it will lose $67 in case the price reaches $161.
With a share price currently around $80, that should be no problem, right? Wrong. Alibaba clearly stated they will only buy 15 million shares now and the rest later. And because they bought the $161 options, a price that isn't exactly around the corner, it's clear they won't buy the remaining 33 million shares anytime soon.
This exposes them to a potential loss of 33 million shares multiplied by $67, or $2.2 billion, be it in the form of cash or issuing new shares (fewer earnings per share), in case the share price rises to $161.
Now, what happens above $161? That's when the call options kick in. Alibaba agreed with the note holders that beyond that price, it has the right to buy back the shares at $161 from them, effectively canceling out any further upside.
Bottom line, the maximum upside for the note holders is $56 per share plus interests. The maximum downside for Alibaba is $67 per share it didn't buy below $94. With the call option as proof, Alibaba is willing to lose $2 billion to get its hands on $5 billion offshore.
I'm left with two questions.
1. Why does a company with $60 billion in net assets have to resort to these kinds of financial constructions?
2. Why are they only buying 15 million shares now, leaving $3.3 billion in the bank?
The first question can probably be explained by the fact that Alibaba isn't allowed to move even a relative small portion of its assets offshore, while it had plenty of time to do so.
The second question is anybody's guess. Do they think the price will go down in the future, giving them plenty of time to buy below $90? Or do they need money for operations or expansion abroad? No idea.
It's a small price to pay.
Compared to the $25 billion of buybacks since 2022, $2 billion can be considered small, agreed. But as a standalone transaction, paying 40 cents to get your hands on an offshore dollar is close to insanity, thank you China.