Alibaba: There's Always Something To Fear
Summary
- Investing in Chinese stocks like Alibaba has always been fraught with emotional landmines.
- Before fears of the VIE structure possibly nullified by Beijing and delisting concerns were in vogue, short-sellers had created panic for BABA shareholders alleging accounting irregularities.
- In 2018, the bear camp pushed the trade war as a damaging driver for BABA stock, along with the perennial "coming collapse of China."
- Bears have also touted the moral dilemma in getting investors to avoid BABA stock, despite a lack of understanding of China.
- I argue in this article that circumstances could change (when reality trumps rhetoric) resulting in Americans having a more favorable view of China, thereby improving investor sentiment on BABA stock.
Bunpoht Baimiden/iStock via Getty Images
The share price of Alibaba Group Holding Limited (NYSE:BABA) has been on a downtrend since November 2020. Over the past year, there were several occasions when many Wall Street analysts and writers, including yours truly, believed BABA stock had reached a turning point. On 14 March 2022, esteemed JPMorgan analyst Alex Yao threw in the towel, downgrading his rating on Alibaba and slashing his price target on the company's stock to $65 a share from $180.
BABA stock has been on a downtrend since peaking in October 2020 (YCharts)
The subsequent wide coverage of JPMorgan’s capitulation worsened already fragile sentiment, culminating in a “sum of all fears” moment. BABA stock plunged to a multi-year low of $76.76. The next day, BABA staged a remarkable rebound.
Unfortunately, the fears that led to the panic selling did not disappear. Even if they did, there will be fresh ones created to spook investors. I know this very well, having written on Alibaba Group since 2017, becoming a shareholder in that same year, and following the news on the company way before that. There is always something scary about BABA stock.
Competition is “crushing” Alibaba Group
Before the world knew of Pinduoduo Inc. (PDD) or heard of ByteDance’s TikTok (BDNCE), market players were worried that Alibaba Group’s e-commerce dominance would be threatened by an up and coming JD.com Inc. (JD). Indeed, the share of China’s retail e-commerce sales occupied by Alibaba Group shrunk from 58.2% (according to eMarketer) in 2018 to 47.1% in 2021. JD.com saw its share rise from 16.3% in 2018 to 16.9% in 2021. Pinduoduo gained the most among the trio, expanding its share from a mere 5.2% in 2018 to 13.2% in 2021.
Nevertheless, that has not stopped Alibaba Group from scoring substantial gains in e-commerce sales. eMarketer projected in May 2021 that Alibaba would grow its retail e-commerce sales from $920.4 billion in 2019 to $1.33 trillion in 2022, an increase of $409.1 billion or nearly the full projected sales of Pinduoduo in 2022 at $422.8 billion. In fact, Alibaba’s 2022 retail e-commerce sales are estimated to be around $300 billion larger than the next six online retail players combined. Is this really a sign that Alibaba Group is losing its leadership in online shopping?
eMarketer
Likewise in cloud computing, Alibaba Group’s huge lead has also been eroded by other players over the years. From a hefty 43% market share in 2018, Alibaba Cloud held only 37% of China’s cloud infrastructure services spend in 2021.
China cloud infrastructure services spend in 2021 (canalys)
However, despite so-called “highly damaging” policy regulations impacting the growth of the industry, Alibaba Cloud still managed to grow 30%, “driven by long-term consumption commitments from key clients and expansion of its business in traditional industries,” according to Canalys. Is a 30% growth amid plenty of adversity really that disappointing and concerning?
There’s something fishy about Alibaba Group’s accounting
Investors who came across BABA stock due to the COVID-19 pandemic may not have known the biggest fear in 2018 was about Beijing or the entire hoo-ha about Variable Interest Entities [VIE]. It was the alleged accounting “red flags” at Alibaba Group and how the e-commerce and cloud computing giant was “cooking the books.”
The fraud accusations often appear convincing at first glance but upon further checking, the veracity of this claim began to be questionable. The continued bashing of Alibaba’s accounting by famed short-seller Muddy Waters Research inspired me to pen an eight-point counter in Alibaba: Dear Muddy Waters, Here Are My Responses.
It’s very intriguing to me that even Alibaba’s harshest critics have stopped raising accounting fraud issues. Before 2020, it was also common to read in the comments field of BABA articles about warnings over Alibaba Group’s possible financial shenanigans. Was it because a large sovereign wealth fund had "significantly invested" in Alibaba and its fintech arm Ant Group? Perhaps, it is simply that fearmongers have realized investors are becoming savvier and will not easily fall for such old-fashioned fraud allegations.
The coming collapse of China
The idea that China is heading for disaster was perhaps first perpetuated by Gordon Chang in his book titled The Coming Collapse of China, originally published in 2001. 21 years later, the world is still waiting for the country’s “collapse in the near future.”
Google search results
The 2008 global financial crisis did not sink China. The supposedly punitive trade tariffs on China imposed by the U.S. led to a sell-off in Chinese stocks on fears that the Chinese economy would be negatively impacted by the trade war. Nonetheless, the GDP growth for 2018 at 6.6% met economists’ expectations.
The COVID-19 outbreak in early 2020 seemed poised to be like the proverbial straw that broke the camel’s back for the Chinese economy. However, China turned out to be the only major economy in the world to grow positively, leaving naysayers red-faced yet again.
Surely the draconian regulatory crackdowns on the internet and property sectors last year would crush the Chinese economy, some thought. The unabated shipping logjam and the power crunch in the third quarter of last year leading to curtailed manufacturing activity must be the final nail in the coffin! Amazingly, China went on to post a GDP expansion of 8.1% to $17.7 trillion in 2021, exceeding the whole of the European Union [EU] for the first time.
In the past weeks, my email inbox has been bombarded with news about the lockdowns in numerous Chinese cities, including China’s largest metropolis of Shanghai, the capital city of Beijing, and the manufacturing powerhouse of Guangzhou. The Associated Press described the latest COVID wave in China as “extremely grim” on April 6, 2022.
AP news
It has been more than two weeks since and Shanghai remains under lockdown predominantly. We can only assume the situation has become much grimmer if we have not read any more updates following the AP article. Meanwhile, despite the COVID disruptions beginning in March, China still managed to grow 4.8% year-on-year in the first quarter of 2022, surpassing the consensus forecast.
With China’s three core growth engines - infrastructure, manufacturing, and real estate development - spluttering, would the country be able to create miracles, defying formidable adversities again this year? We wouldn’t know the 2022 GDP growth data until next year but I am certain that talks of an economic slowdown in China would only become louder amid rising recessionary pressures. BABA bears will likely use the weak economic backdrop as a selling catalyst.
The Variable Interest Entity structure adopted by Chinese ADRs is a ticking time-bomb
Bears will be baying for my blood if I do not mention the VIE structure as a risk for investors. Never mind that the China Securities Regulatory Commission [CSRC] reiterated its implicit support for the VIE structure last year. I suppose short-sellers also want us to ignore the statement declaring Beijing's support of the Chinese economy and the capital markets following a meeting in March of the top finance policy body chaired by Chinese Vice Premier Liu He. Does it matter that Liu is known as the right-hand man of Chinese President Xi Jinping?
Chinese ADRs are slated to be delisted due to the HFCAA
On April 2, the Chinese regulators finally confirmed plans to revise confidentiality rules to give U.S. auditors full access to the U.S.-listed Chinese firms’ audit reports. Bloomberg had reported a day earlier that the change could happen as soon as the middle of this year.
As if sensing that market players weren’t taking it seriously, the regulator followed up with a reiteration of its commitment to facilitate overseas IPOs on April 9. CSRC Chairman Yi Huiman said in a speech to a business group that the regulator “will keep the channel of overseas listings unclogged.”
Recall that due to the enactment of the Holding Foreign Companies Accountable Act [HFCAA], and the recent naming of ADRs to the warning list by the SEC, delisting concerns have been escalating. If Beijing is really going to allow full access to the SEC for inspecting the audit books, Chinese companies would be able to comply with the HFCAA and avoid delisting.
The White House would need to come up with another excuse to get rid of Chinese ADRs. Judging by how long HFCAA took to become effective, BABA shareholders may have a year or more to take a breather.
China’s invasion of Taiwan
Following Russia’s invasion of Ukraine, readers on Seeking Alpha have noted the risk of mainland China’s takeover of Taiwan will similarly invite sanctions from the international community, sinking Chinese stocks like BABA the way Russian stocks were pummeled. With Beijing’s long-stated desire to bring Taiwan back to its fold by whatever means necessary - including the use of military force - such concern is not unfounded.
However, military pundits continue to reiterate, even recently, that Beijing is expected to only "use force if Taipei crosses Beijing’s redlines," citing the Military and Security Developments involving the People's Republic of China 2021 report published by the Office of the Secretary of Defense. Thus, the understanding is that, if Taiwan doesn’t declare independence, the Chinese government will not be forced to show its hands. Of course, the next question is, will Taiwan do so?
Researching on this topic, I realized the reputable ones are saying that despite the political rhetoric, Taiwanese Presidents cannot make Taiwan independent unilaterally. As the analysts at The Diplomat put it, Taiwan has strong institutions with rules and regulations for constitutional change. If the president can boldly declare Taiwan independent, it would be “akin to an authoritarian power grab that would forgo all of Taiwan’s established democratic institutions.”
It would be the most ironic if the Taiwanese leader behaves in a manner like those the island administration abhors. Furthermore, the Taiwan population overwhelmingly rejects immediate independence, according to polls, favoring the status quo which avoids conflict across the Taiwan Strait.
With the conflict in Ukraine occupying the attention of militaries in the U.S. and Europe, it is unlikely the U.S. government wants an escalation in the Taiwan issue. President Xi is focusing on his reelection later this year and there are plenty of economic pressures to deal with, potentially keeping Beijing busy until next year. Again, Taiwan is happy with the status quo, fearing that the calculus may change if additional antics provoke the mainland into action.
Thus, the media may find talking about a potential Taiwan invasion a reliable eyeball catcher. However, BABA stock could eventually rerate upon the market realizing reality trumps rhetoric and remove some China discount as a result.
The ethical/moral hurdle
For the brave, there is also the moral hurdle to overcome when considering an investment in BABA stock. The narrative that investors, Americans especially, shouldn't buy Chinese stocks like BABA because that is helping China often creeps into the comments section.
Renowned CNN host Fareed Zakaria noted that “(i)nternational relations are often about choosing strategy over ideology,” when explaining why the Biden administration is expected to end the international “ostracism” of Saudi Crown Prince Mohammed bin Salman despite the supposed atrocities he has committed. The White House is hoping Saudi Arabia will produce more crude oil to squeeze out Russia and “get oil prices down.”
Remember, the U.S. is painting a negative light on China as the latter is its “strategic competitor.” This has led to Americans considering China as “the greatest enemy of the U.S.” and “the greatest threat to their country.” However, Michael Pettis, a professor of finance at Guanghua School of Management at Peking University and a nonresident senior fellow at the Carnegie Endowment for International Peace, pointed out that “the biggest threat to American economic supremacy isn’t China.”
Twitter
Can it be possible that one day, the U.S. reverses its hostile approach toward China to secure the latter’s cooperation for American interests, resulting in Americans having a more favorable view of China? When this happens, it will be the biggest boost to BABA stock.
Why BABA when you can FANG?
Last year, many readers commented in my articles on Alibaba asking why should investors buy BABA stock when they can invest in FANG stocks “which are no-brainers.” Well, of the four names, two have given shareholders major heartaches thus far. The share price of Meta Platforms (FB) is down 44% since my article highlighting the ESG push by Alibaba and Pinduoduo. Last Wednesday, Netflix (NFLX) plunged 36% after it reported a reduction in net subscribers and Bill Ackman bailed out of the stock, taking $435 million loss.
Some readers may argue the share price of BABA has fallen more when viewed on a longer basis. However, bear in mind that an average American stock portfolio would have a much heavier weightage of FANG than BABA. The precipitous fall of FB and NFLX stocks is bound to create hefty damage to many American investors, more so than BABA would have.
On Thursday, former President Barack Obama said in his speech at Stanford University that he expects transparency requirements for tech companies, including regulations that mandate them to share data with researchers. Most interestingly, he wants tech companies to “have some other North Star, other than just making money, and increasing market share.”
This sounds a lot like what Beijing is demanding of its Chinese internet companies. However, no one is saying President Obama is unreasonable or not investor-friendly. Perhaps when market players realize this similarity, the Chinese discount on BABA can be reduced.
Alibaba Group’s revenue growth prospects have been impaired by the regulatory changes but the current valuation seems to have factored this in. According to the consensus estimates, it is expected to grow double-digit percentages in the next three years (2023-2025). By 2027, if the share price remains the same, its price-to-sales ratio would fall below 1.0 times.
Alibaba revenue estimates (Seeking Alpha Premium)
After a year to forget, analysts are expecting Alibaba Group to post positive EPS growth again in 2023. Thereafter, the EPS estimate is forecast to grow in double-digit percentages through 2028 when the price-to-earnings ratio falls to a mere 5.4 times.
Alibaba EPS estimates (Seeking Alpha Premium)
Analysts could revise their estimates downwards further. Nevertheless, based on the recent trends, the pace of reduction has slowed significantly for both EPS and revenue estimates.
Alibaba EPS revision trend (Seeking Alpha Premium) Alibaba revenue revision trend (Seeking Alpha Premium)
Meanwhile, Alibaba Group continues to invest for the future. Nikkei reported that Alibaba is leading a $60 million funding round for smart glasses maker Nreal and that it has invested at least $1 billion in AR and VR startups in recent years.
Ant Group is also fortifying its global capabilities. It recently acquired 2C2P Pte. Ltd., a Singapore-based company that facilitates enterprises in Southeast Asia to move money across borders, even as “its efforts to get back into domestic regulators’ good graces near completion,” according to Caixin.
If Alibaba Group and its various affiliates keep on making appropriate add-ons and expand internationally, Wall Street analysts may decide to revise their estimates for the company upwards. This will be welcome news, though I expect the change in investor sentiment to be a bigger driver for BABA stock in the near term when market players come to appreciate my view points as elaborated in this article. Looking forward to hear your perspective.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of BABA, JD 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.