Alibaba Bears Bet On China Meltdown

| About: Alibaba Group (BABA)

Summary

Alibaba's stock will come under pressure through the middle of the year due to short selling interest tied to China's correcting stock markets.

But shares should see some upside in the second half.

Wall Street is shorting the stock at levels not seen since late 2014.

Bottom line: Alibaba's (NYSE:BABA) stock will come under pressure through the middle of the year due to short selling interest tied to China's correcting stock markets, but the shares should see some upside in the second half.

In what looks like a case of history repeating itself, the bears are suddenly piling into shares of leading e-commerce company Alibaba, with investors shorting the stock at levels not seen since late 2014. Company watchers will recall that the last time Alibaba bears were so active was shortly after its record-breaking IPO, when the stock was soaring as legions of short-term investors traded shares in pursuit of quick profits.

That initial post-IPO hype is now well in the past, and so are most of the lock-up periods that were posing some potential downside to the stock in its first year of trading. That means that rather than focusing on company-specific issues, this time the short sellers are betting on something much bigger: a prolonged downturn in China's economy. That would affect the entire retail sector, including Alibaba's core e-commerce business.

In particular, the short sellers seem to be betting on more turbulence in China's domestic stock markets, which have shed 17 percent since the start of the year. Shares of most US-listed Chinese companies have moved in tandem with that drop, and Alibaba's own shares are down 14 percent since the start of the year.

I'm personally quite bearish on the Chinese stock markets right now, and believe they could have an additional downside of up to 20 percent before things finally settle down. But that said, I also think that any concurrent sell-off of Alibaba's shares looks a bit reactionary, and suspect the shares could stabilize sooner than their China-traded counterparts and see some good upside in the second half of the year.

I'll return to my own thinking shortly, but first let's review the latest reports that say short selling interest surged to a full 7.5 percent of Alibaba shares outstanding on January 21 (English article). That's more than double the level from early December, and would mark the highest level since November 2014, shortly after Alibaba's record-breaking $25 billion New York IPO.

Some of the bearish bets may be tied to Alibaba's upcoming fourthquarter earnings announcement, which will come on Thursday this week in New York (earnings calendar). I personally doubt we'll see any big surprises in that announcement, though the heavy bets by the bears could mean that even a small miss in profit or revenue could put downward pressure on the stock.

Bearish Bets Pressure Stock

Reflecting the huge pressure now weighing on the company, Alibaba's shares actually fell nearly 1 percent in the latest session on Wall Street and were down another 0.5 percent after hours. That drop was significant because Shanghai's composite index actually rose 0.75 percent earlier the same day, meaning Alibaba's shares broke with their broader recent trend of following the Chinese markets.

All that said, the bigger questions become: What's ahead for Alibaba's performance and how will that translate into its stock price? In terms of fundamentals, the company's shares now trade at a multiple of about 30 for the current fiscal year, according to my own calculations. That looks quite reasonable if one assumes the company can maintain its recent profit and revenue growth of 20-30 percent.

But that said, US investors seem to be more focused these days on China's stock markets, which looks somewhat illogical, rather than the actual business of Alibaba and other US-listed Chinese companies. That means Alibaba is likely to come under continued pressure, perhaps justifying the huge surge in short-selling interest.

A slowdown in Alibaba's growth rate looks almost inevitable in any scenario due partly to the company's own large size and market share and China's own economic slowdown that's likely to accelerate. But that said, I do expect Alibaba's shares to de-couple from the Chinese stock markets by the middle of this year, at which time the shares could see some potential upside as the bears exit and longer-term investors return.

Disclosure: None.