- Alibaba stock is now trading at about the same valuation level it was during the Chinese stock market crash in 2015.
- The Chinese economy faces much bigger fundamental problems than it did during that crisis, so BABA still has room to correct further.
- What if BABA's cheap multiples are just justified by weakening profitability and marginality levels?
- Seeing all this and sensing the danger, institutional investors continue to close their positions at the expense of those who are "fooled" by the apparent cheapness of the stock.
- I rate BABA as "Neutral", amending the previous "Bearish" rating in the hope that CCP's rhetoric towards Big Techs may change to stop capital outflows.
Intro & Thesis
Perhaps you already know that the reason for this sell-off was the announcement DiDi Global (DIDI) made about delisting from the NYSE and the subsequent placement of its shares on the Hong Kong Stock Exchange.
DiDi's plans were seen as in reaction to reports that the Cyberspace Administration of China had asked company officials to work up a plan to delist its shares from stock markets in the United States. Chinese regulators have been cracking down on many of the country's largest tech companies this year over matters ranging from anti-competitive business practices to the management and security of consumers' data, and now speculation is likely to grow over whether or not more Chinese tech companies that trade in the U.S. will depart for stock exchanges back at home.
Source: SA News
Many of BABA's bulls among the SA contributors were quick to reassure that a) the risk of delisting does not apply to BABA and b) that investors have nothing to worry about in the long run. However, I disagree with the second point of this statement - I will try to present the logic of my reasoning in this article.
China went too far with regulation, sparking a massive foreign capital outflow.
It is quite difficult to argue with this, especially if we look at the data on China stock margin balance:
Source: The Daily Shot
Please note the date in the upper left corner of the image above - November 30, 2021, i.e. before the last news about the planned delisting of DIDI. By that time, BABA stock had already fallen to critically low levels, if you look at the P/E multiple dynamics:
And yesterday's fall has once again confirmed that BABA still has a "reserve of power to the downside":
At first glance, it may look like the stock has fallen pretty low in terms of price-to-earnings (P/E) ratio - one of the main arguments bulls use to call for buying the dip. However, over a longer period, we see that the P/E ratio was already at about the same level during China's stock market crash in 2015:
Source: Ycharts, author's notes
Here's how CNN's article explains the root cause of the 2015 panic on the Chinese stock market:
Over the past year, investors poured more and more into Chinese stocks, even though economic growth and company profits were weak.
Source: CNN Business
That is, at that moment, a bubble simply inflated that could only burst because of deteriorating indicators of the country's economic growth - at that moment, the Shanghai index lost about a third of its value before recovering.
Today we see a similar picture emerging in the face of the Evergrande liquidity crisis. In general, Chinese developers are now periodically struggling to meet their commitments.
Evergrande Group's struggle to comply with official pressure to reduce debt has fueled anxiety that a possible default might trigger a financial crisis. Economists say global markets are unlikely to be affected but banks and bondholders might suffer because Beijing wants to avoid a bailout.
Source: Apnews.com, dated December 3, 2021
A Chinese real estate developer [Kaisa Group Holdings Ltd.] warned Friday it might fail to pay off a $400 million bond due next week, adding to financial strains in an industry that is struggling to avoid defaults on billions of dollars of debt.
Source: Apnews.com, dated December 3, 2021
One third of China's property developers will struggle to repay their debts in the next 12 months, according to a new report, as the sector reckons with increasingly serious headwinds from falling sales, restricted access to credit and a wider downturn.
Source: The Guardian, dated October 28, 2021
This comes against a backdrop of declining demand for new homes in China. According to Bloomberg, new home sales in four tier-one Chinese cities continued to fall in the first week of September (year-on-year):
Institutional investors cannot help but incorporate these risks when assessing their investments in China in general and in BABA in particular; therefore, we are witnessing a colossal foreign capital outflow, which is unlikely to decrease shortly.
In addition to the high risk of a liquidity crisis in China, institutional investors are also looking at the behavior of the regulator, which I have written about earlier (here). The Chinese Communist Party's attempts to control the data Big Techs collect about their users robs companies of significant advantage in doing business - without enough data on hand, it's difficult for BABA's and other companies' algorithms to make high-quality inferences about user behavior and recommend products they might be interested in based on that data.
The risk of receiving large fines related to antitrust laws also weighs on companies, as does competition for the main end-market, due to which JD holds up significantly better than BABA over the past few months.
The recent quarterly report from BABA also contributed to the markets' re-rating (I wrote about that report in more detail here). Against a backdrop of rising revenues, we saw a falling EBITDA margin, which raises many questions about BABA's valuation - perhaps the falling multiples are just justified by weakening profitability and marginality levels?
Considering all the risks described above, I do not think now is the perfect time to buy the dip that still cannot stop hitting new laws.
Yes, BABA looks very cheap in terms of its market multiples, especially when compared to its Western counterparts.
However, such a comparison cannot be considered appropriate, as the difference is in the discount rate investors use when discounting future cash flows - something tells me that BABA will have this rate 2-3x higher than that of, say, (AMZN). Amid falling margins and profitability - a trend that could prove to be more than just temporary - BABA cannot be considered a high-quality value buy either.
Seeing all this and sensing the danger, institutional investors continue to close their positions at the expense of those who are "fooled" by the apparent cheapness of the stock:
On the other hand, you need to understand here that many of those who have closed long positions in recent months are ready to get back in on the backdrop of even insignificant positive news about BABA - precisely because of "apparently tempting" fundamental undervaluation. But when exactly this good news will see the light of day - no one knows. However, I suspect that China has yet to change its rhetoric regarding the Big Techs like Alibaba; otherwise, the country's economy will have a tough time in the face of the developing liquidity crisis in the real estate sector. On this basis, I rate BABA "Neutral", changing the previous "Bearish" rating, which has aged quite well since the first article was published:
Source: Seeking Alpha
I remain skeptical of the VIE structure and caution you to consider the risks before buying BABA or any other Chinese company.
Happy investing and stay healthy!
This article was written by
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