Alibaba: SEC Makes A Move

Summary

• US and Chinese regulators have finally struck an agreement that allows for the audit inspections of Chinese stocks.
• But even with the agreement in place, the delisting risk still persists for Alibaba and other such impacted firms.
• Risk-averse investors may want to avoid the stock for the time being.

Guang Niu

There's been a lot of furor surrounding Alibaba (NYSE:BABA) of late. Chinese and US regulators have finally reached an agreement last week under which the former will allow the latter to conduct unfettered audit inspections of several hundred Chinese companies. This development reduces the outright delisting risk for US-listed Chinese companies such as Alibaba, but investors shouldn't celebrate too soon. Specifically speaking, the agreement doesn't solve the underlying issues and Alibaba may still be faced with the delisting risk in the US. Let's take a closer look to gain a better understanding of it all.

Reasons to Cheer

Let me give a brief background for the uninitiated. There was an accounting fraud at a Chinese company called Luckin Coffee back in 2020. The company was listed on US exchanges and US-based investors lost their capital due to the scandal. So, in order to prevent such mishaps from happening again and to protect the interests of its citizens, US regulators instated the Holding Foreign Companies Accountable Act (or HFCAA) along with its underlying framework that would require foreign companies to open their books to audit inspections, or risk getting delisted by 2024.

The SEC published several provisional lists over the course of the past year, enlisting non-compliant Chinese companies such as Alibaba that were at risk of getting delisted in the US. There was only one problem - the Chinese government was not complying. See, Alibaba or its auditor, on their own, did not have the freedom or authority to open up to audit inspections from US regulators and had to first seek approval from the Chinese government. From its last 20F filing:

PricewaterhouseCoopers, our auditor, is required under U.S. law to undergo regular inspections by the PCAOB. However, without approval from the Chinese government authorities, the PCAOB is currently unable to conduct inspections of the audit work and practices of PCAOB-registered audit firms within the PRC on a basis comparable to other non-U.S. jurisdictions. Since we have substantial operations in the PRC, our auditor and its audit work are currently not fully inspected by the PCAOB, and as such, investors of our ADSs, Shares and/or other securities do not have the benefit of such inspections.

But in what's being hailed as a landmark deal, Chinese regulators have finally allowed audit inspections by the Public Company Accounting Oversight Board (or PCAOB) of the US. The goal is to comply with the SEC's listing requirements and prevent mass delisting of Chinese stocks from US bourses especially during these times of macroeconomic turmoil. But don't bet the farm on Alibaba just yet. While this agreement is a good start and a welcome news, there's still a lot of ground to cover to eliminate the delisting risk for Alibaba and other such impacted Chinese stocks.

Delisting Risk Still Persists

There are broadly three arguments to be made here. First, Alibaba and JD.com will be amongst the first Chinese companies that will be inspected by US regulators in September. There isn't any precedent on how strictly does PCAOB conduct its audit inspections on Chinese companies. If the inspections are politically motivated, then the US regulators are likely to highlight all possible accounting irregularities regardless of their scale or magnitude. But if US regulators are just looking to ensure that the broad strokes of GAAP accounting standards are being followed, then the inspections are likely to be lenient and rather uneventful. Only time will tell what gets unearthed in these inspections.

Secondly, one might speculate that Alibaba's auditor is globally-renowned PricewaterhouseCoopers so US regulators will surely go easy with their inspections on the company. But that's not necessarily a given. Many other Chinese companies that made it to SEC's provisional lists of potential delisting, have reputed Big Four auditors, yet they're in the same boat with Alibaba. So, I think it's best to not assume anything at least until the inspections begin.

Company filings, BusinessQuant.com

Third, we don't yet know what kind of turbulence will these inspections unleash. For instance, will the accounting irregularities, if any, be as huge as Alibaba overstating active users, or as minor as misrepresenting petty cash. Also, will the PCAOB issue a written request to Alibaba, asking it to address the accounting discrepancies, or will that notification be backed by a yet another delisting threat. Depending on the findings and the scale of discrepancies, Alibaba and other similarly impacted firms may also be asked to restate their financials.

The point that I'm trying to make here is that only the audit inspections will reveal the true size and scale of accounting irregularities, if any. Without knowing the outcome of these inspections, we cannot rule out the delisting risk for Alibaba and other similarly impacted Chinese stocks. Let's remember that Chinese and US regulators have only agreed to conduct audit inspections so far, but that in itself doesn't address the issue of following US GAAP accounting standards. If anything, this is the time when accounting irregularities are likely to show up and market panic may ensue.

Investors Takeaway

It's worth noting that Alibaba's shares are currently trading at just 2.1-times its trailing twelve-month sales. This is quite low by industry standards, especially when compared to some of the other rapidly growing e-commerce companies. So, the stock does seem to be undervalued, at least according to this parameter.

BusinessQuant.com

But it's important to understand that the delisting risk still persists for Alibaba. Only the PCAOB inspections will reveal whether Alibaba is in accordance with the US GAAP accounting standards or if it has to restate its financials. So, I believe the stock is basically a gamble at this point, that can swing in either direction in the coming weeks.

With that in mind, risk averse investors who don't have the appetite for portfolio drawdowns and are prioritizing capital preservation, may want to avoid the stock for the time being at least. However, contrarian investors with a far greater risk appetite and tolerance for volatility, may want to consider accumulating the stock while it's still seemingly undervalued. Good Luck!

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.

Comments

[TheFounder]

The fear of delisting is highly exaggerated. Delisting is not a bankruptcy.

The HK market has thousands of traded companies, more than 100 years of tradition and an aggregate market cap of USD trillions.

BABA will flurish there.

[sbwiad33]

@TheFounder to me delisting to a communist country would mean game over you lost everything. I think delisting fear is justified no one wants their money disappear in a dictator lead country. Imagine investing in North Korea stock exchange lol do they have one ? Then someone says don’t worry about delisting you be ok.

[TheFounder]

@sbwiad33
So there are over 2500 companies currently traded in HK which did not "disappear in a dictator lead company" as you suggest. Not 1, not 15, but 2500+. This is one of the major markets in the world so no need to spread baseless fear. Millions of investors are making money there.

[John_III_XVI]

@TheFounder Forced delisting from NYSE would result in an even lower bottom from panic induced sell off. And a loss of access to general American investors who do not shop foreign exchanges for investments.

If HKEX was such a good deal, I am sure Alibaba would have paid for a HKEX primary listing instead of the cheaper secondary listing they have now. When your interest is money then you choose #1, not #4.

I expect Alibaba to pass their audit in the next 4 to 6 weeks & keep their NYSE listing. And continue seeking a primary listing on HKEX. Should be business as usual after that for the Cayman Island VIE stock "BABA".

Of course global recession, war sanctions, energy crisis, Chinese & American economic slow downs, Chinese COVID lock downs & their real-estate mess will be huge headwinds to growth.

Tough climate for day trading. Caveat emptor. ;>) God bless.

[shogan]

Chairman Xi and his clan is from Snaghai. Politburo de facto took complete control of all vital conglomerates, CCP deems of vital importance to China's security and military complex.

[sbwiad33]

Finally a reasonable Article and rating of Hold is correct. The final verdict of this year compliance on accounting audits thumbs up or down won’t be known till December until then great uncertainty looms over Chinese stocks. Any SA Author issuing Strong Buy is misleading readers into unknown risk for which they have no idea what they are talking about. At this point a Strong Buy on any Chinese company which could be delisted is equivalent to saying “we don’t know what will happen so risk/reward is high like Bitcoin so therefore Strong Buy”.

[Business Quant]

Thank you for the kind words, @sbwiad33 .

[EliasMouawad]

BABA is ready to jump higher but the general market isn't helping

[Shaduc]

@EliasMouawad china lockdowns are devistating that economy

[Business Quant]

Out of curiosity, @EliasMouawad , which data points suggest BABA is ready to rally?

Thanks,
BQ

[EliasMouawad]

@Business Quant In addition to the audit agreement, more Chinese stimulus...strong support above $89 while the 200 day moving average is falling day after day.

[mac ron]

Seams to me, that it is entirely possible that one or some Chinese listed stocks financials are not GAP compliant. Ok, but does anyone really believe that most or all of them are engaging in systematic fraud. Surely fraud of that wide scale would be found out over time. Muddy waters et all would have found that out already. I’m not expecting a big fraud problem.

[Shaduc]

@mac ron there are 2 global acctg standards eu or usa.
this is the fault of the SEC for not doing its job.
but they were competing with hk for ipos.

[Business Quant]

Completely agreed with you, @Shaduc , this should've been done more than a decade ago.

Best,
BQ

[Shaduc]

@Business Quant when I "studied" this 2006-7, I assumed the SEC, Wall Street Regulators were already doing this.
Instead they they were greedy for IPOs
not sure how many comparisons to Didi there are, but definitely Luckin Coffee fraud

[grandherve]

Another cheap Commie trick. They engage in uncontrolled laughter when
agreements are reached with us Western dopes. They make monkeys out
of us daily, as we continue to believe that they are sincere. Not good.

[TheFounder]

The delisting risk makes the stock uninvestable by many US institutions.

So we get a valuation which reflects the risk of bankruptcy or restructuring, only without the actual bankruptcy or restructuring risk.

Whichever the outcome will be at the end, the uncertainty will go away and it will still be a growing and profitable global company which spends billions on share buyback programs.

This is called a market dislocation.

Upside: $180-250/share and trade on a US exchange
Downside: 20% less and and trade in HK.

[Business Quant]

Okay, fair point, @TheFounder , but are you factoring in that BABA's growth itself has slowed down considerably due to macroeconomic reasons, lockdowns, regulatory crackdowns and because it no longer can function as a monopoly (thanks to the antitrust fine)?

[asantana86]

cue the commentors about how the CCP takes an iron fist to Baba and cannot be trusted while simultaneously ignoring what the US Gov just did to NVDA and it's revenue streams in foreign countries....

[Tell_it_like_is]

Buying hard and buying fast and going long. Incredible sale and opportunity get in at this price. "Be greedy when others are fearful" WB

[Finance Tiger]

Chinese are smart, intelligent and hard working people but under the stupid management of Mr. Xi who is killing all the golden geese companies with his zero covid policy tool.

[Duffy Duck]

@Finance Tiger
Mr. Xi is on top because he was smarter, more intelligent and working harder than most of the smart, intelligent and hard working Chinese. I would also not neglect 1.5 M Covid deaths in God’s Own Country, but bashing from the sofa is fun, right?

[davel]

@Duffy Duck

Because political leaders are always smarter, more intelligent and harder working than others..

[Duffy Duck]

@davel
Not sure about that, but it is not my point anyway. I feel uncomfortable that people - often with below average IQs -have many platforms to spit out their momentary frustrations without the need to think about it beforehand.

[Greenhorn Investor]

Thank you for the article

[Godspeed Trader]

@Greenhorn Investor best attitude you can find on SA

[Business Quant]

Indeed, @Godspeed Trader

[John_III_XVI]

This is a very long-winded way of saying the agreement has opened the door to inspections BUT the inspection results must be positive to have FUTURE positive results. Duhhhhhhhh...

I have been a skeptic but my biggest roadblock was the lack of access for USA inspectors. Huge roadblock removed. I think the rest of the process will work itself out. And, in short, time will tell. ;>) The risk from the CCP using their companies like cookie jars still exists as is China's own economic woes.

I don't expect BABA to get much cheaper. For anyone who has been waiting for a buy signal it might be the right level & time to start buying. Just remember it is still China in the ironfisted control of the CCP.

[Tell_it_like_is]

@John_III_XVI Buying hard and buying fast and going long. Incredible sale and opportunity load up at this price. "Be greedy when others are fearful" WB

[grandherve]

@John_III_XVI Buy signal??? Check with CCP, they are superb chartists.

[John_III_XVI]

@grandherve You forgot the "might be" & "still China" warning that followed immediately after. ;>)

[Z Dougie Dub]

I love to gamble. Long BABA and long PDD.

[Shaduc]

@Z Dougie Dub baba and pdd aren't gambles. Just when they pay off is questionable.

I bought $20k options

[fredex]

@Shaduc What timeframe of options are you looking at?

[Shaduc]

@fredex over 1 year. lost $8k

[Djreef1966]

The reason I now hold the 9988.HK shares.

[ajmacknz]

@Djreef1966 the percentage price change will be the same whether it is 9988.HK or BABA.

What you have done by changing to 9988.HK is in the worst case of delisting is got around the rush that would ensue to transfer from BABA to 9988.HK, also you can trade 9988.HK local time rather than BABA in its local time. I say rush because if it was told it had to delist this usually occurs in a reasonably short time period.

[Djreef1966]

@ajmacknz It wasn’t last night.

…And it won’t be if BABA is delisted.

The entire process took 2 weeks.

[Analyst_question]

@Djreef1966 are you comparing closing prices in NY vs HK, otherwise the prices will move in parallel. The conversion is:

BABA price = 9988.HK price x 8 / (HKD / USD, about 7.8 at the moment)

If for instance a delisting announcement was made after the close of business NY time then after hours BABA price would drop, but opening 9988.HK price would also have dropped.

Thanks I have been considering changing to 9988.HK too but as I understand it they have till something like 2024 to have the audit done and with recent announcements it seems like China and the US may be moving toward an agreement.