Alibaba: This Is A Regulatory Game-Changer
Summary
- Chinese and U.S. regulators are said to near an agreement about audit inspections.
- An agreement would pave the way for Alibaba and other Chinese companies to remain listed on U.S. stock exchanges.
- The risk analysis just fundamentally changed.
maybefalse/iStock Unreleased via Getty Images
Shares of Alibaba (NYSE:BABA) surged last week on reports that Chinese regulators could allow the U.S. Public Company Accounting Oversight Board to inspect audit reports from Chinese companies with overseas stock listings. The news is a big deal for companies like Alibaba which have been subjected to growing concerns over a securities delisting in FY 2021 and FY 2022. With delisting concerns out of the way, investors could start to focus again entirely on Alibaba's actual e-Commerce performance and considerable free cash flow!
This might be just the regulatory game-changer the market has been waiting for
According to a recent Bloomberg news report, the China Securities Regulatory Commission is said to work on a framework that would allow U.S. regulators to inspect the books of more than 200 Chinese companies with ADR listings in the U.S. Granting the U.S. Public Company Accounting Oversight Board full access to audit reports of Chinese companies could put to bed a contentious issue that has plagued Chinese companies with ADR listings in the United States, like Alibaba, for more than a year. Chinese companies only present unaudited financial statements to foreign shareholders, opening them up to criticism about a lack of transparency. Investors buying U.S.-listed ADRs have no assurances that the financials Chinese companies submit can be relied upon.
For more than a year, many investors have been fearful to touch Alibaba's ADRs, in part because Beijing was cracking down on Chinese companies with overseas securities listings. While I considered Alibaba's ADR delisting risk to be minuscule all along -- largely because it is not in Beijing's interest to cut off its own companies from the ability to raise foreign investor capital -- investors can now feel reassured that the U.S. and China are moving towards an amicable solution regarding audit inspections.
The news is a big deal for Alibaba and other Chinese companies with ADRs trading on U.S. stock exchanges. This is because the Securities and Exchange Commission listed five Chinese companies -- including Yum China, BeiGene, Zai Lab, ACM Research and HUTCHMED -- as possible delisting candidates a short while ago which sparked another sell-off in Alibaba's ADRs.
Beijing's concessions to the U.S. are a positive step in the right direction and a mutually agreed on framework for audit inspections clears the way for growing investor interest in Alibaba's e-Commerce empire and significant free cash flow value.
Growing e-Commerce empire and free cash flow
The biggest reason to buy Alibaba relates to its incredible free cash flow value and the most recently announced $25B share buyback. Alibaba's free cash flow remains largely ignored and I believe it has a lot to do with delisting fears that have weighed on Alibaba's ADRs.
In the first nine months of FY 2022, Alibaba generated 113.94B Chinese Yuan in free cash flow which calculates to $17.9B. Alibaba could generate up to $28.0B in free cash flow next year and achieve free cash flow margins close to 20%.
Alibaba
Alibaba recently upsized its share buyback from $15B to $25B which is a considerable amount of cash that will be returned to shareholders in the next two years. The firm's top line is also expected to keep growing, although at a smaller rate than in the past. We are likely going to see around 20% top line growth for Alibaba annually in the foreseeable future.
With margins of around 20%, regarding free cash flow, shares of Alibaba still remain fundamentally undervalued... and the collaboration regarding audit inspections could clear the way for a higher valuation of Alibaba's shares going forward.
Alibaba's current market price implies a free cash flow valuation factor of just 8.6 X. The P-FCF ratio has been calculated by adjusting Alibaba's market cap of $300B for its considerable net cash position of $59B and dividing it by my free cash flow prediction of $28B for FY 2023.
Based off of just sales expectations, shares of Alibaba have a market-cap-to-revenues ratio of 1.7 X, which is significantly below the sales multiplier factors achieved a year ago.
Risks with Alibaba
As I have said along, the ADR delisting risk has been widely blown out of proportion and Alibaba and other large Chinese companies with ADR delistings in the U.S. are unlikely to see their shares getting delisted. The most recent developments are highly encouraging. However, this is not to say that Alibaba doesn't have any risks. The biggest risk for Alibaba remains a slowdown in top line growth longer term, especially in its e-Commerce business which is still responsible for 70% of the firm's revenues. Lower free cash flows and declining free cash flow margins also represent risks for Alibaba and the stock going forward.
Final thoughts
I suspected that the U.S. and China would reach an agreement on audit checks. The most recent report from Bloomberg suggests that U.S. and Chinese regulators work on a mutually beneficial solution to keep ADRs of Chinese companies tradable in the U.S. Beijing is making big concessions here and I believe it will ultimately benefit Alibaba as well as other Chinese Big Tech companies. With ADR delisting concerns out of the way, investors can now try to focus on Alibaba's actual commercial performance and free cash flow again.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BABA either through stock ownership, options, or other derivatives. 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.
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Comments (220)
Matthew 15:11 ESV It is not what goes into the mouth that defiles a person, but what comes out of the mouth; this defiles a person.”
¯\_( ツ )_/¯
Unfortunately it's sentiment that is driving the markets right now and technical analysis is not much good here. Might I suggest buying put options to protect you from any further falls. 3 month expiry date should do it.
These are articles and Q &As from the SMCP. They are very enlightening about the very real possibility of this slowdown mentioned in the article.www.scmp.com/...
Putting a precise number to the growth shock is no easy task. There are simply too many unknowns – pertaining to the length and breadth of the outbreak, the type of containment measures employed (not all affected regions will engage in full lockdowns), and how production can be shifted across supply chains to avoid output losses.
But what is clear is that economic growth has contracted sharply in March, on a sequential basis, consistent with the weak PMIs last week. As Covid-19 woes persist, April could be even worse if more regions upgrade social and mobility restrictions. With little prospect of growth in the first half of the year, the odds of China achieving this year’s 5.5 percent GDP growth target are becoming increasingly slim."
Per the South China Morning Post today.
As China faces its biggest Covid-19 outbreak yet, the economic impact of the government’s strict approach will make it difficult to meet annual growth targets
There are signs the policy is being recalibrated to prepare for living with the virus, but the moderation will do little to ease growing pains in the near term"
"The economic cost of strictly adhering to a zero-tolerance approach is mounting as a growing number of cities implement lockdowns. Shenzhen put its economy on hold for a week in late March and was successful in stamping out the outbreak. Shanghai – China’s largest city with 24 million people – has been in a two-phased lockdown since last week. But significantly higher infection rates – partly due to the city’s late response – meaning that the battle may take longer to win."www.scmp.com/...
www.tradingview.com/...