Alibaba: The Aftermath Of The Crackdown

Summary

• The regulatory crackdown has brought the largest Chinese tech companies to their knees, including Alibaba, but the encouraging news for easing regulation on Big Tech provides a strong vote of confidence.
• The increased compliance with anti-monopoly practices has already been reflected in Alibaba's financials with falling profit margins due to opened up competition for the company.
• Regulations have not crashed Alibaba's operations, but the softening domestic spending, global supply chain disruption, Russia-Ukraine war, and domestic Covid restrictions further extend the short-term headwinds.
• Despite the continuing stock market meltdown, Alibaba is a business I feel comfortable with being invested in through the bear market.

Koki Nagahama/Getty Images News

Investment Thesis

Alibaba Group (NYSE:BABA) has recently jumped on the news for easing CCP scrutiny and collaboration with SEC. However, even though the news proposes a positive political development, it wasn't a catalyst factor to support BABA stock above the $100 level, despite the temporary surge in shares. Therefore, the market remains very sensitive to political updates, and investors are not convinced of Beijing's intentions.

In previous articles, I have emphasized that Alibaba's shares are driven purely by sentiment and political developments rather than the company's underlying fundamentals. Thus, having a solid understanding of the CCP, US-China relations and other interrelated factors tied to Alibaba is vital for developing expectations of the stock price movements.

While many investors and analysts are fixating on Alibaba's fundamentals which is the most prudent way to assess an investment, those factors are no longer relevant under the current political environment. Therefore, investors should prioritize understanding Alibaba's and China's politics over 'deceiving' fundamentals.

Trading BABA on the news might be an investment strategy for day traders, and if you are an investor with a short-term investment horizon, you might reconsider prior investing with BABA. However, I remain invested with BABA for the long term. Moreover, the recent political developments that provided a strong vote of confidence reaffirmed the strong buy rating at current share price levels.

Clear Signs of Positive Development

In a recent article from South China Morning Post, an Alibaba company, the publisher highlighted China's new policies to support Big Tech platforms. The CCP's crackdown has wiped out an outrageous amount of about $2 trillion from Chinese tech stocks for months, but the positive news created a sizable but temporary pop in all KWEB ETF constituents. Justifiably, China remains uninvestable for many investors, and there is still a long way to go until Chinese financial markets rebuild trust to attract foreign capital.

Data by YCharts

Connecting The Dots Two Years Later

Following the ANT Group's IPO cancellation back in 2020, for many, China has become uninvestable due to political uncertainty and the prolonged regulatory crackdown. Almost two years later, the tight regulation and increased compliance costs have already been reflected in the company's financials, but the direction only gets clearer from here on out.

Favorably, a delisting for BABA is unlikely, as explained in an earlier article. According to US regulation, the company needs to control at least 66% of shareholder votes for voluntary delisting, implying that Alibaba needs around $91 billion for share repurchases and passing the resolution. However, suppose the price drops to $70; in that case, some may argue that the company could be forced to partially or fully deploy its nearly $78 billion in cash reserves in conjunction with additional debt or equity financing to buy back its shares and eventually delist from the NYSE. However, this argument would be valid in the absence of a cooperation plan between US-Chinese regulators.

Alibaba responded wisely by efficiently deploying its massive cash reserves to boost its buyback program to $25 billion despite the meltdown. As a result, this will meaningfully support the stock price in the medium term while richly remunerating patient long-term investors.

Data by YCharts

Regulations Have Not Crashed Alibaba As Expected

Undoubtedly, the anti-monopoly rules enacted have interfered with Alibaba's economic moat and have increased competition which is reflected in the diminishing margins. However, despite the regulatory hurdles with elevated compliance costs, the company has already built an empire. Its strong competitive advantage is supported by the profound network effects, automated logistics infrastructure, leading monetization strategies, and market share dominance.

Data by YCharts

Easing Regulation & The New Norm

America's corporations and lobbies have become too powerful and exert significant influence over political decisions, signaling a 'Corporate Democracy' system or 'Corpocracy'. To that effect, American corporations have gained a disproportionate power in the society that can manipulate the market as they wish, but the US has not taken sufficient measures regulating big tech, data protection, or implementing strong anti-competitive practices. On the contrary, the Western world views China's measures as catastrophic for capitalism, despite China's aim to develop a sustainable and healthy infrastructure for global business activity.

Thus, news about China's easing regulations on Big Tech has given strong confidence in the market. However, it remains to be seen in action how easing will unfold and whether the CCP will maintain its stance in supporting the financial markets and China's tech companies. Similar to the "Brussels Effect," which caused a spillover effect globally with enhanced regulation for compliance with GDPR rules, China is about to create the "Beijing Effect", with the provision of enhanced regulation rewriting global economic rules.

China's economy is poised to surpass US's by 2030, and international companies cannot afford to lose access to this growing market. As a result, sooner or later, global companies will be forced to comply with Chinese law and practices, similar to what happened with GDPR, leading 8 out of 10 American companies to comply with GDPR rules. To that effect, Mr. Market is being too harsh with China's developments as any news coming out has a short-term pump effect on Alibaba, but it's not enough to maintain the stock price above the $100 level. Alibaba is the 4th largest Chinese company by market capitalization, and the company will grow in line with China, Southeast Asia, and global markets.

What Investors Should Expect

In the recent quarter, the softening of domestic spending has negatively affected Alibaba's revenue growth. Moreover, this quarter the global supply chain disruption, the Russia-Ukraine war, and domestic Covid restrictions further extend the short-term headwinds. Thus, BABA is heading towards difficult times, and the upcoming quarterly results might not be that strong.

According to Jika.io, the most correlated domain is aliexpress.com, but the relationship remains relatively weak, which accounts for the company's top three domain names. Indeed, Alibaba is a technology conglomerate with many subsidiaries across e-commerce, logistics, media and entertainment, cloud computing, fintech, and other sectors. As a result, it would be debatable whether traffic analytics would be strong enough to develop a reasonable prediction.

jika.io Alibaba domains' traffic (jika.io)

For instance, taking aliexpress.com as a leading traffic indicator, the organic traffic in the last quarter remained relatively flat with no significant movements. Moreover, the downward trend in the latest quarter has stabilized with no further drops in traffic volumes. On the contrary, taobao.com and alibaba.com reported minor declines since March.

Aliexpress.com Traffic (semrush.com)

On a longer horizon, the organic traffic for alibaba.com peaked in November 2021, a year after the ANT Group IPO suspension and the regulatory crackdown. Inevitably the anti-monopoly practices have opened up competition for Alibaba and have also drained valuable human capital resources during the compliance period. Nevertheless, Alibaba reported 953 million annual active users in the latest quarter, and it is on track to reach the one billion mark this quarter, dominating the far majority of the 1.2 billion online population market.

Alibaba.com Traffic (semrush.com)

Alibaba Cloud Is Stronger Than Ever

Remarkably, Alibaba has managed within two years to expand its global market share from 5% to nearly 10% by May 2022, surpassing Google cloud, being behind Amazon and Microsoft. Undoubtedly, cloud computing has become a commodity, and Alibaba's superiority in cloud infrastructure, server chips, and RISC-V will be the ultimate drivers of its future growth. Moreover, China's cloud infrastructure is expected to double in three years, and considering Alibaba's nearly 40% domestic market share, the company is well-poised to capitalize on the upside.

China cloud infrastructure services spend forecast (www.chinainternetwatch.com)

Concluding Thoughts

The market continues to test the patience of BABA's investors. Despite the continuing stock market meltdown, Alibaba is a business I feel comfortable with being invested in through the bear market. Winston Churchill famously said, "Never let a good crisis go to waste," and the political fiasco with China's regulatory crackdown and now the bear market has put one of the best businesses in the world on sale, trading at a deep discount. Intelligent investors with long-term investment horizons might consider jumping on this opportunity as we navigate through the storm.

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.

I have a beneficial long position in the shares of Alibaba Group, through both NYSE: BABA and HKG: 9988. More than 95% of my position is held in 9988 through Hong Kong Exchange.

Comments

[EliasMouawad]

Nice article. BABA is rising today. It's rising on heavy volume.

[Blueper]

Alibaba is a joke! Have any of you-all ever used it to buy products? Again....it's a bad joke. The "marketplace" of Alibaba is nonexistent. I have tried to make deals with the "marketers" (people operating from a garage with a phone) on Alibaba dozens of times over a ten year span with ZERO SUCCESS. This was for my company, legitimate volume orders. I would estimate the fraud on Ali-the-baba to be ABOVE 90%.

[47977204]

BABA is held by Chinese citizens as well as Foreigners and by Mutual Funds. It’s downfall has greatly damaged the finances of many families.

China does not care and the takeaway is never buy any Chinese stock, period.

[Bugle Boy]

I might invest in BABA or other Chinese stocks if Jack Ma was seen walking alone in San Francisco.

[doug pfister]

I've made money on BABA twice. Now the risks have gone up. I have a measly 10 shares & expect that in a year or 2 I'll pay my long term capital gains & buy a case of wine, make a home or car repair with the money.

[Godspeed Trader]

Is BABA a good buy?

A: yes, a goodbye.

[lmcmf]

The problem with investing in Chinese companies is that because China continues to have a communist regime that prevents direct investment in Chinese-based companies.
therefore investing in Alibaba listed on American stock exchanges or in Hong Kong is not investing in the real Alibaba company based in China.
For example I can buy 100% of Alibaba listed on the stock exchanges and I cannot appoint any Administrator in the real Alibaba company based in China. In essence, investors are investing in a company that receives profits from the rents on houses that are owned by another company.
It's similar to a real estate business but Alibaba listed on the stock exchanges doesn't own any property, it just takes the profits.
These so-called VIE structures do not have the same value and risk as investing in the ownership of a company, being able to appoint the company's management and be able to decide on the possibility of changing or influencing decisions that affect the company's business.
Therefore, as long as China's communist dictatorship does not allow direct investment in companies based in China, it is impossible to make investments in companies based in tax havens that have a VIE structure that do not represent the ownership of the company based in China.

[DScid]

@lmcmf I sympathize with your argument, and it makes good sense. However, the overwhelming number of US investors lack even a minuscule fraction of the capital needed to affect corporate decisions. Only a few can dream of having enough money to affect the corporate decisions of Tesla or Amazon, and you can forget about overruling Elon Musk or Jeff Bezos’s decisions. So while your argument is solid, in practice US investors are too small to have little real power to control corporate decisions.

[lmcmf]

@DScid yes agree

[Paul Claussen]

"Hello! McFly!" The BABA dog has been in an unrelenting downtrend for more than 15 months. There is a brand new chart pattern that accurately describes this phenomenon. That pattern is called: "Double Black Diamond". This pattern reflects a Steep, Downward, Bumpy and Dangerous trajectory. I encourage everyone to spend 5-10 minutes taking a stroll down memory lane and look back at all the headlines for SA articles on for BABA over the past two years. There are many including article after article from authors (sometimes 10+ articles from a single author) claiming BABA had finally bottomed, it is too cheap, "the more it drops the more I buy" and similar nonsense. The bottom line is that the market clearly told us this dog was on a Double Black Diamond. If you bet against the trend, you lost. All of those who insisted on calling a bottom have consistently been catching a falling knife. How did we ever get this far? It's so unnecessary. This is a very simple chart to read. When the trend breaks, then (and ONLY then) consider dipping your toe in the water. Otherwise, stay away. Good luck to all.

[DScid]

@Paul Claussen Sentiment too is a good indicator. When every author on SA has abandoned BABA, then it will be a good buy.

[Paul Claussen]

@DScid Thanks. As I write this, the ratings on SA are listed below. SA Authors maintain a Buy rating. Quant is a Hold. The author of this article has a "STRONG BUY" rating.

BABA Ratings
SA Author Buy 3.90
Wall Street Strong Buy 4.50
Quant Hold 3.08

[arok79]

@Paul Claussen These same so called gurus have had a "strong buy rating" for last year+ now. All it's done is put in a 70% drop in that amount of time. So don't waste your time reading these FURUs. They are clueless when it comes to CCP headwinds. BABA has been another outstanding short last 15-16 months. Stellar returns on put options.

[eurdone88]

I sold all my Chinese stocks because I'm sick of them enabling Russia.

They are uninvestable because of what they're doing and going to do to Taiwan. They learned no good lesson from Ukraine.

[MplsSnowball]

@eurdone88 Would you take the same approach with American tech companies if the US government started taking actions that you strongly disagreed with? Or would you separate a country's businesses from the actions of such county's government?

[eurdone88]

@MplsSnowball
Chinese dictator controls Chinese companies.

I'm a US citizen so I should be investing in US stocks mostly. They also have the best history of producing gains so it makes financial sense to do so.

US companies have a lot more autonomy than Chinese or Russian companies, so its easy to separate them. Maybe I would have a problem buying defense ETFs when America was invading Iraq, but no reservations since its Russia being the aggressor now.

My tech heavy portfolio is already being battered by interest rates, but I'm not selling, I'll keep buying shares since I believe in their future and want them to succeed. I thought China would behave in order to achieve economically... but it seems they've remained bad actors, so I'd rather they not succeed. I don't want to profit at the expense of Taiwan, and I don't trust the Chinese government not to invade.

[Niarb Namtih]

"Help, I've fallen and I can't get up."

Stock pricing these days has nothing to do with the companies any more. It's ambient noise that drives pricing. What did Putin say? What did the CCP say? What did Elon Tweet? What did the SEC say? What did Rubio or Cotton puke? What did Sanders or AOC puke? What fake story did Bloomberg print? Which oh-so-sensational story is CNBC hyping? And of course Powell is approved for another term because he did suck a good job (I puke). At least there is some consolation in knowing he'll feel the pressure of cleaning up his own mess.

IDK, how bout if we double the Fed balance sheet to $18 Trillion. Have congress write checks to everybody for another $4 Trillions. Pay off everyone's student loan debt for another $1.5 Trillion. Raise the minimum wage to $20/hr. There, that should do it. ---- Finally, a real crash can happen so we can get back to investing in companies and what they produce.

Nah, probably won't happen.

Anyway. I'm very long baba, but I've fallen and I can't get up.

[mendo]

I am not afraid of China, but of US doing something similar as they have done to shareholders of Russian companies. What do you think?

[Bucs1234]

@mendo I haven't been thinking in that regard. I trust no one in government on our side of the ocean, either, so yes, good question

[Tellurium128]

@mendo exactly. With Chinese stocks, you're not just gambling on the kindness of dictator Xi, you're also gambling on the insanity of the US government. Do you really trust either? Let alone both at the same time

[lmcmf]

@mendo Investing in Chinese companies with VIE structures is more risky than investing in Russian companies.