Alibaba’s (NYSE:BABA) fate rests in the hands of Chinese and US regulators, both of whom have more than enough instruments to delist the company’s shares from the US exchanges for different reasons. While in the past the idea of the possible delisting of a company such as Alibaba was something out of ordinary, the recent political developments on both sides of the Pacific make it clear that even the biggest tech giants of this world are not immune to the actions of the opposite, belligerent to each other governments. Going forward, there’s a high chance that in the not so distant future Alibaba could be forced to be delisted from NYSE, as the latest underperformance of its stock, which was caused by the involvement of China in the company’s internal affairs, proves that nothing is impossible at this stage. For that reason, I continue to believe that China’s tech sector remains uninvestable in the foreseeable future, as not all of the political risks have materialized to this day, and it’s better to avoid investing in Alibaba no matter how undervalued its stock might be.
In my latest article on Alibaba, I’ve discussed how the Communist Party of China started to strengthen its grip over entire industries to get greater control over the nation’s economic and political life, and how it used its aggressive actions against companies like Alibaba to silence its political opponents. On top of that, the article explained how China’s government found a way to continue to extract more resources from Alibaba by stripping away its Key Software Enterprise status, which gave it preferential tax treatment, and by indirectly forcing it to spend $15.5 billion in the following years on the state’s Common Prosperity development fund. While the involvement of the state in Alibaba’s affairs alone makes it hard to justify a long position in the company, there’s another issue that makes investing in Alibaba extremely risky, and unfortunately, it hasn’t been discussed as broadly as it should be.
While China started to open up to the Western world back in the 1970s under the leadership of Deng Xiaoping, the country continues to restrict and prohibit investments in various industries, which have utmost importance to the national security to this day. The country still prohibits foreign direct investments in most of its biggest tech companies such as Alibaba, and to circumvent such restrictions, Chinese firms used the variable interest entity structure (VIE), which helped them to raise money and indirectly get access to the US capital markets. Under the VIE structure, mainland companies use a complex web of law loopholes to sign contractual agreements and share their profits with offshore entities that are located in safe havens such as the Cayman Islands. After agreements are signed, offshore entities themselves apply for the approval of the SEC to be listed on US exchanges. That’s why when we look at Alibaba’s reports to the SEC, we see that it’s incorporated in the Cayman Islands, which implies that investors who purchase the company’s stock are actually purchasing not a real Alibaba, but an offshore entity that has close connections with its Chinese counterpart.
The problem of VIEs is that investors in reality have no control over the direction in which the real business will go and have no voting rights. At the same time, VIEs don’t use GAAP accounting standards and are extremely risky to own. A few years ago, Alibaba’s former CEO Jack Ma decided to spin off Alipay, which was then fully owned by Alibaba, into a separate entity. At that time, Yahoo held a sizable stake in Alibaba and was opposed to the actions of Jack Ma. However, since Yahoo owned a sizable stake of Alibaba’s VIE and not the real Alibaba, it couldn’t do anything to stop the spin-off and no regulatory body could’ve helped it to protect its rights.
While in the past Beijing was silent about the use of VIEs, shell offerings came at the center of attention last year when the Chinese government began its crackdown on Alibaba. In addition to political reasons, Alibaba also became a target due to its size and importance to Beijing, since it’s one of the biggest gatherers of personal data, as the majority of the Chinese population is part of the company’s ecosystem through the use of its marketplaces and apps. As the Communist Party of China aims to digitize the nation’s economy and control the flow of data within the mainland, it seems that Alibaba will play a crucial role in helping it to achieve its goals, as was explained in my latest article. China has already passed several data laws, which define different types of data, including data that is of the utmost importance to national security, and the country’s cybersecurity administration has the right to oversee how the laws are implemented by firms such as Alibaba. Considering that tech companies collect and store the most amount of data in China and are strategically important to Beijing, it’s safe to assume that it’s unlikely that foreigners will be able to invest in them directly anytime soon.
That’s also why there’s a risk that Beijing might officially declare the use of VIEs by its firms illegal since they still help its entities to raise foreign funds, even if it’s indirectly. Just a few days ago, rumors started to surface that China’s other tech firm DiDi (DIDI) is being asked by the Chinese regulators to create a plan for the company’s delisting from the US exchanges. Considering this, there’s a possibility that the same fate might await Alibaba in the foreseeable future. Therefore, owning Alibaba even at the current undervalued levels is still extremely risky. Since China is ruled by a one-party under a civil law legal system, nothing will stop Beijing from enforcing its will on the private sector, as there will be no opposition to stop it from doing so.
Most bullish articles that are written on Seeking Alpha about Alibaba ignore the fact that the US government could also force the company and other firms that use the VIE structure to be delisted from its exchanges. While in the past the possibility of such an event happening has been extremely low, the increased hostilities between China and the United States signal that the tides are turning. Let’s not forget that Alibaba’s share price has been depreciating in recent months due to the involvement of China in its affairs, leading to a lot of US investors suffering significant losses. To protect its investors and prevent further losses caused by China, the US government is ready to take action as well.
The SEC now requires all listed VIEs to disclose all the risks of investing in such entities, while the US government in late 2020 passed a law called Holding Foreign Companies Accountable Act (HFCAA), which requires foreign firms to open up their books to US auditors, primarily to The Public Company Accounting Oversight Board (PCAOB). To comply with the law, auditors of public firms must give access to the financials of those companies to PCAOB in order for the latter to execute an audit. If auditors of foreign public companies decide to decline PCAOB requests for an audit three years in a row, then those companies are going to face the delisting of their shares from the US exchanges.
Considering that for years, Beijing has discouraged foreign auditors from inspecting the books of its companies, it’s safe to assume that it will not budge now and give a green light for the companies of strategic importance to open up their books to the US auditors. On top of that, the increased hostilities between the Chinese and US governments will also make the cooperation between different governmental authorities extremely hard, if not impossible. Therefore, it’s safe to assume that the chances of Alibaba being delisted from the US exchanges in the following years are extremely high right now.
Let’s not forget that earlier this year the US government through an executive action already forced NYSE to delist China’s major telecom companies from the exchange. The same fate might await Alibaba very soon.
Investing in Alibaba on an open market means indirectly investing in China’s strategic sector, which Beijing prohibits in the first place. Therefore, investors are exposed to numerous political risks that don’t justify having a long position in a company such as Alibaba for the long term. On top of that, it’s only a matter of time before the US government gets involved as well and starts to regulate Chinese firms more strictly. As a result, it doesn’t matter what Alibaba’s valuation is at this stage, since its fate is in the hand of regulators from China and the US. Considering the recent developments on both sides of the Pacific, I stick to my opinion that Alibaba continues to be uninvestable, as there's a high chance that it will be delisted from the US exchanges in the foreseeable future.
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It was there that I started to combine my academic knowledge with a passion for investing to build an all-weather portfolio that could overcome periods of constant economic and political uncertainty. Given the systemic shocks that have been happening to Ukraine in the last decade, I saw firsthand what’s it like to live in an environment where there’s too much unpredictability and no guarantee that your endeavors won’t fail. Despite this, I managed to show strong returns and since 2015 have been sharing some of my ideas here on Seeking Alpha.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Bohdan Kucheriavyi is not financial/investment advisor, broker, or dealer. He's solely sharing his personal experience and opinion; therefore, all strategies, tips, suggestions, and recommendations shared are solely for informational purposes. There are risks associated with investing in securities. Investing in stocks, bonds, options, exchange traded funds, mutual funds, and money market funds involve risk of loss. Loss of principal is possible. Some high risk investments may use leverage, which will accentuate gains & losses. Foreign investing involves special risks, including a greater volatility and political, economic and currency risks and differences in accounting methods. A security’s or a firm’s past investment performance is not a guarantee or predictor of future investment performance.