Alibaba: Too Big To Succeed

Mar. 09, 2022 12:41 PM ETAlibaba Group Holding Limited (BABA)122 Comments20 Likes

Summary

  • Despite strong fundamentals and being extremely well positioned in its market, Alibaba has failed to make upward progress in the stock market.
  • Alibaba's business - from its size to its endeavors - are in direct conflict with the CCP's tenets and China's current five-year plan.
  • I suspect Alibaba is on its way to becoming nationalized.
  • This idea was discussed in more depth with members of my private investing community, Timing the Market. Learn More »
Yahoo Takes 40 pct Stake in China"s Alibaba

Guang Niu/Getty Images News

  • An average earnings growth of 22% per year.
  • A debt-to-equity ratio of under 13% and falling.
  • Direct access to the biggest and fastest-growing consumer market in the world.

On paper, Alibaba (NYSE:BABA) seems like the perfect company. It’s a Chinese Amazon, eBay, and PayPal all rolled into one entity, with access to a market four times as large as that of the United States. Yet the stock has fallen over 66% from its all-time high in spite of China’s continued economic expansion.

I thought the stock was cheap at $160. Many of you remembered, which is why I’ve suddenly become inundated with questions as to whether sub-$100 BABA is worth a buy. I’m sorry to say that I’ve flipped sides: Too much has changed in the last six months.

What Happened?

As I look over analysts’ articles on BABA, I see a lot of “undervalued,” “oversold,” “strong cash flow” – fundamental and technical bull theses. But recently it has become apparent to me – and assumedly many others who are selling their positions – that the underlying business strength is not the company’s strength but the problem. The problem is the application of Western financial logic to a Chinese company, which follows different rules.

If Amazon gets too strong, throwing its weight around, it might get a slap on the wrist in the form of a fine from the FTC. Or it might have an announced acquisition blocked. But the boundaries in which Amazon is allowed to grow are flexible and wide.

Alibaba gets no such leeway.

In the past six months, the Chinese Communist Party (CCP) has made its stance on Alibaba being too big for its britches increasingly palpable. In fact, things began to heat up at exactly the same time I posted my last article, recommending BABA as a buy – talk about bad timing! The Central Commission for Discipline Inspection started investigating Hangzhou’s CCP secretary, Zhou Jiangyong, citing legal violations. Hangzhou just so happens to be the city in which Alibaba is headquartered, and Zhou Jiangyong has long been suspected of concealing his stake in Ant Group.

Alibaba owns around one-third of Ant Group, which was supposed to IPO last year at $37B. The IPO would have been the most expensive in history, but the IPO registration expired in November last year during the CCP’s investigation. Alibaba stockholders lost a large growth catalyst with the IPO fizzling out; the stock has been on a downtrend since, with every subsequent piece of news for the company pointing to increasing government pressure.

Increasing Pressure

Essentially, every news item regarding Alibaba in the last few months have hinted that the company is being strong-armed by the CCP. Jack Ma, Alibaba’s co-founder, has been out of the public spotlight for nearly two years. It is unclear as to who is making Alibaba’s decisions behind the scenes.

Interestingly, with Jack Ma currently out of the picture, we suddenly have a $15.5B donation from Alibaba to the Chinese government’s common prosperity development fund. Note that the size of this donation is roughly half of the IPO valuation of Ant Group. I do not believe that this donation was on behalf of BABA’s shareholders and is most likely part of a continuing dismantling of Alibaba.

We also have China’s Ministry of Industry and Information Technology withdrawing its partnership with Alibaba due to the latter’s failure to report a bug. This action is almost certainly done with malice on the government’s part, as the law being cited mentions nothing about an obligation to report bugs to the government. The CCP seems to be using any excuse to put pressure on Alibaba.

Alibaba Will Be Nationalized

I believe that China’s end game with Alibaba is to nationalize the company, further solidifying the centralization of power. I am not the only person who suspects this. CCP’s tenets call for the nationalization or destruction of any private system that is too influential, ever-present, or centralized. Moreover, China’s 14th five-year plan, which acts as an actual doctrine for CCP policy, specifically states that a major goal for these five years (starting in 2021) is a “crack down on monopolies.”

Alibaba is a particularly important target for nationalization due to synergy of Alipay with digital RMB, China’s digital currency that was launched last year, and due to the threat Ant Group, which was focused on further decentralizing finance in China, to the People’s Bank of China (PBC). Alipay (and cryptocurriences, already banned in China) currently dominates the mobile payment market in China, the largest mobile payment market globally, and is thus an obstruction to the success of digital RMB.

This becomes clearer once you realize that Alipay payments are not actually in RMB. Instead, they are made with a virtual currency issued by Alibaba, backed by Alibaba’s RMB reserves. The payments are equivalent in value to RMB but are essentially employing a digital currency outside of the PBC’s control. I believe the end result will be Alipay integration with digital RMB, a situation that certainly is not ideal for Alibaba nor its shareholders.

Conclusion and Trade Idea

Basically, “money equals power” does not hold true in China. Nor does “too big to fail.” In fact, in China, if you get too big, you will fail by necessity (at least as a private company).

The very fact that Alibaba is the Amazon, eBay, and PayPal of China gives BABA extra downside risk and a lower probability of long-term success. At present, the CCP’s actions toward Alibaba point to further pressure and a potential government acquisition of some or all of the company, which of course means share liquidation and/or stunted future growth. I henceforth give BABA a “strong sell” rating, expecting a bottom in the $50s, a little above the 1x P/B ratio, at which the stock price is unlikely to reasonably (read: with mathematical justification) fall further.

Upward movements seem unlikely at this point without a change in the political relationship between Alibaba and the CCP. As we have seen with earnings, even good fundamental numbers do not lead to buying rallies. Of course, Jack Ma could suddenly appear on the public stage, announcing that the CCP has changed its mind and will allow Ant Group to IPO, but I find that just as unlikely as Putin suddenly walking back his Ukraine intentions. Some political situations are just too solidified to bet against.

A short makes sense here, if you can handle the unlimited upside risk. I dislike unprotected positions and prefer put options. Should you too prefer short positions via options, I suggest buying out-of-the-money monthly put options and taking profit on large downward movements. For example:

Buy Mar18 $90 put.

Take profit on the next gap down or large red candlestick. This play will allow you to speculate on further downside movements at little cost and no risk (besides the option premium, which is roughly $150 per contract for the Mar18 $90 puts).

Let me know what you think.

Editor note: I am professional fluent in Chinese, having lived in Taiwan and China most my life, acting as a translator. Some links in this article may be in Chinese.

Want to know whether your stock outperforms given a certain month? Check it out:

Timing the Market



...click here to see what members are saying.

This article was written by

Damon Verial profile picture
18.25K Followers
Get our seasonal portfolio and earnings trade ideas

Damon Verial is a statistical analyst who uses his skills to research stocks, options, and investment strategies. In addition, Damon is the writer of Copy My Trades, a trade-alert, subscription-based newsletter, available at his personal website. He is also the writer of Exposing Earnings, an in-depth earnings prediction service here on Seeking Alpha.

.

Damon makes his living as a gap trader, an earnings trader, and an interday trader. In his free time, he writes for Seeking Alpha, where he focuses on seasonal investing, market timing, and earnings analyses.

.

Damon has written several successful stock analysis algorithms, including algorithms that can predict gap closure, intraday patterns, and news overreactions. They will soon be publically available for subscribers.

.


Damon’s undergraduate education was in statistics and mathematics at the University of Washington; his graduate education was in psychology at National Taiwan University. He currently lives in Fukuoka, Japan.


Follow

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Short position through short-selling of the stock, or purchase of put options or similar derivatives in BABA over 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.

Recommended For You

Comments (122)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.