Alibaba: Brace For Impact

May 25, 2022 12:20 PM ETAlibaba Group Holding Limited (BABA), BABAF53 Comments

Summary

Alibaba will report its FY22 earnings report on Thursday.
So far, China's crackdown against the tech sector hasn't fully ended yet, so it's unlikely that Alibaba will show outstanding results due to the constant interference from Beijing.
Even if the stock rebounds soon, the momentum is likely going to be short-lived due to the economic challenges that Beijing is facing.

China Celebrates 100th Anniversary Of The Communist Party At Mass Gala — Lintao Zhang/Getty Images Entertainment

Alibaba (NYSE:BABA)(OTCPK:BABAF) is about to report its FY22 earnings results this Thursday. After months of the depreciation of Alibaba's stock, the company's investors are eager to finally hear some good news from the management that could improve the overall situation. However, for over a year Alibaba has been a hostage to Beijing and its policy, which is aimed at strengthening the government's grip over the private sector. Due to this, the business has less control over its own fate, and the latest developments show that it can't do much itself to show an outstanding performance anytime soon.

Even if there's going to be a rebound in Alibaba's share price after the earnings report comes out, the momentum is likely going to be short-lived, as China's economy currently struggles to tackle the pandemic challenges, which makes it harder for Beijing to achieve its political goals. This will undoubtedly have a direct impact on Alibaba and its peers, as it will be challenging to present a positive outlook in the current volatile environment. For that reason, I stick to my opinion that Alibaba is uninvestable for the long term and don't expect the situation to fundamentally change after Thursday when the FY22 report comes out.

Politics Over Business

All my previous articles on Alibaba highlighted key risks that started to materialize and destroy shareholder value. Since the publication of my first article on the company, its stock has depreciated by nearly 40% as those risks began to directly affect Alibaba's financials. While some decline in Alibaba's shares could be attributed to the overall market selloff, we should not forget that both NASDAQ and S&P 500 indexes were trading close to an all-time high at the beginning of 2022, while Alibaba's stock was already in a downturn at that time. In the last 12 months, Alibaba's stock declined by around 60%, while NASDAQ and S&P 500 indexes declined only by 19% and 7%, respectively, during the same period. Therefore, the initial catalyst for Alibaba's depreciation wasn't the overall market selloff. That's why the goal of this article is to describe what exactly has happened and more importantly analyze how China's current macro environment could affect the company's business in the future, without reiterating points that were highlighted in my latest articles.

There's no denying that Beijing's policy is mostly to blame for the value destruction that we've witnessed in Alibaba's stock in recent quarters, as political agenda began to dominate over the economic prosperity of the tech sector. After Xi Jinping went after his political opponents who had close connections with Alibaba founders in late 2020, the company itself experienced an unprecedented attack from China's regulators. The Q4'21 report, which was released a year ago, showed that for the first time since its IPO Alibaba reported a quarter with a net loss due to the record $2.8 billion fine that was imposed on the company by authorities from Beijing. In addition, Alibaba was likely forced to commit $15.5 billion over the next several years, which amounts to nearly 20% of its total liquidity at the end of Q3, to fund Xi Jinping's Common Prosperity policy.

On top of that, higher taxes significantly undermined Alibaba's ability to show outstanding performance. In Q1'22 when the effective tax rate was in the single digits, the company generated nearly $7 billion in net income. However, once the rate was increased to a double-digit percentage, Q2 and Q3 net income was only $851 million and $3.2 billion, respectively. Going forward, the key tax rate will stay above 20% due to the more hawkish fiscal policy from Beijing, so days of showing outstanding bottom-line results are gone now as well.

New Challenges Arise

Another problem is that while Beijing managed to strengthen its grip over Alibaba and its tech peers via the passage of a number of regulations, which I discussed broadly in my latest articles, it still can't fully tackle the economic challenges, which will negatively affect China's private sector. The energy crises that erupted in the second half of 2021 along with the fall of Evergrande made it even harder for Beijing to accelerate the growth of the economy. What's worse is that the reemergence of Covid-19 on the mainland forced the government to adopt a harsh zero-Covid policy in late March and early April in hotspots such as Shanghai similar to the one that we witnessed at the beginning of 2020.

As movement restrictions were imposed, China's economy began to struggle and in April alone the consumer goods sales decreased by 11.1% Y/Y, while the industrial output declined by 2.9%. On top of that, the youth unemployment in China reached a record 18.2%, and now Beijing targets a GDP growth of only 5.5% in 2022, the lowest in decades. The problem is that in Q1 China's GDP grew less than 5% and due to lockdowns it's unlikely to show more meaningful growth in Q2, especially after the country experienced a collapse in car sales along with supply chain disruptions. That's why some advisory firms already believe that it's unrealistic for Beijing to achieve the targeted GDP growth rate this year.

Considering this, it appears to be certain that those developments are more than likely going to negatively affect Alibaba. The company's stock has already received 13 down revisions in the last 90 days against only 1 up revision, and the economic decline could hamper the business's possible growth in the April – June quarter. As a result, the forward guidance that will be reported on Thursday is likely going to disappoint lots of investors.

Alibaba's eCommerce competitor JD.com (JD) earlier this month already reported its earnings results for the March quarter. While the company reported solid results, there was an indication that its revenue growth has slowed down by the end of the quarter as lockdowns kicked in, leading to the slowest revenue growth on record. In addition, the company is currently experiencing an increase in cancellations in comparison to a year ago, which signals that the slowdown of China's economy due to the reemergence of Covid-19 is also having a big impact on the eCommerce sector. In addition, China's electronics maker Xiaomi (OTCPK:XIACF) also saw a decline in demand and a Y/Y decline in revenues, while the digital entertainment conglomerate Tencent (OTCPK:TCEHY) showed only a 0.1% Y/Y growth in revenues in the March quarter. Considering this, Alibaba is likely going to be negatively impacted by macro events as well given the fact that it directly competes with JD in the eCommerce business and has investments in various sectors of the tech industry.

Risk

The thesis of this article is based on the fact that after more than a year of strict regulations, Beijing has severely undercut Alibaba's ability to successfully perform and return to its pre-crackdown growth rates. Add to this the slowdown of the Chinese economy and it becomes hard to see how Alibaba could successfully perform in the following months. However, there's no guarantee that there's not going to be an earnings surprise that pushes the stock higher since the lockdown shouldn't severely affect March quarter results.

On top of that, there's an even greater catalyst that could undercut any potential disappointing outlook presented by Alibaba on Thursday. As I've said before, any positive announcement by China's state officials alone could push the stock significantly higher as it was a few times this year already. While the crackdown against China's tech behemoths is not over yet, there are signs that Beijing could stop imposing harsher regulations for a while in order to revive the economy and prevent further capital outflow. Just recently, China's officials met with tech executives and pledged support for the tech sector. In addition, there is news that the U.S. and Chinese market regulators are currently in talks to reach an audit deal in which Chinese-based companies will be allowed to open up their books to international auditors in order to comply with HFCAA. A deal between the regulators will undoubtedly give a breath of fresh air for Alibaba's stock and delisting will be out of the question at least for the foreseeable future. However, regulators from both countries have been in talks since last year and so far, no deal has been reached to date. Nevertheless, if the deal will be struck in the foreseeable future, then it's more than likely that the market will positively react to it and it will undermine my thesis.

The Bottom Line

As the world is on a brink of a recession, owning a company that's exposed to a toxic political environment where an autocrat could start a crackdown at any moment is not the brightest of ideas no matter how cheap someone thinks the business is. The good news is that the sudden urgent need to strike a deal with the SEC to comply with the U.S. regulations after years of blocking access to China's books is a sign that Beijing's policy might indeed change soon. This potentially could lead to the rebound of Alibaba's stock in the near term.

However, there's no guarantee that that policy of openness won't be reverted once things settle down. The problem is that Alibaba along with its tech peers will continue to be hostages of Beijing, as data regulations that were passed last year and continue to be passed now are unlikely to be reverted, while the fiscal policy will stay hawkish. In addition, add to that risks that will materialize over time in the cloud, digital payment, and other businesses where Beijing becomes a direct competitor and you'll conclude that Alibaba is not a growth business anymore. That's likely one of the main reasons why the outflow of institutional funds from Alibaba's stock has been greater than the inflow in the last seven quarters in a row. For that reason, I stick with my opinion that Alibaba is not as attractive anymore in the current environment as was the case before the crackdown started. Even if the company reports successful FY22 results on Thursday, any potential rebound momentum is likely going to be short-lived due to the challenges that the business will face during the ongoing economic downturn in China.

This article was written by

Bohdan Kucheriavyi

7.34K Followers

Bohdan Kucheriavyi is a Ukraine-based proprietary trader working at a prop firm. He has been successfully investing personally and professionally since 2015. He combines his knowledge of international relations with his passion for global markets to identify good investments based on momentum and special situations with a specific focus on tech companies.

Bohdan leads the investing group Blacksquare Capital. Features of the group include: an all-weather portfolio, event-driven investment ideas, trade alerts, geopolitical event roundups, a weekly newsletter with updates on all current and watchlist holdings, quarterly market reports, community chat, valuation models - all aimed at helping investors develop an approach to overcome periods of economic and political uncertainty. Learn More.

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