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Risky But Alibaba Is A Buy

|Includes: Alibaba Group Holding Limited (BABA)

By Glenn Rogers, Contributing Editor

I should begin this column by acknowledging up front that this will be a controversial recommendation and not appropriate for our more conservative readers. The company in question, Alibaba Group (NDQ: BABA), has been under a great deal of scrutiny in recent days in part because of a negative article published by Barron's last week.

The stock has fallen from a high of $120 a year ago to $59.24 as of Friday's close (figures in U.S. dollars). That means it is now below its IPO (initial public offering) price of $68. This IPO was the largest in history, raising $22 billion when the company went public last year. This may well be the epitome of a high-risk, high-reward stock opportunity.

For those who are not familiar with Alibaba, it is the Chinese equivalent of Amazon and eBay. There are several ancillary businesses attached to this massive e-commerce company, which operates under the Alibaba Group Holdings banner. They include Taobao, Tmall, eTao, and Juhuasuan.

Jack Ma, whose personal story is well documented in financial publications but bears repeating, founded Alibaba. Ma was a poor boy hanging around hotels in Hangzhou, giving free sightseeing excursions to tourists so he could learn English. He could see the commercial potential of the Internet despite having no programming ability or technical knowledge. He gathered a group of friends and developed a plan to become the premier player in the Chinese e-commerce industry. A more improbable tale you could not imagine and it will probably one day become a movie script. Ma remains the company's chief booster and is a compelling but self-depreciating CEO who has amassed a huge personal fortune from extremely modest beginnings.

The original Alibaba site at alibaba.com is a juggernaut and is China's largest wholesale marketplace. It also operates in a number of other countries around the world, including the U.S.

Until recently the company operated more like eBay in the sense that it did not hold inventory and really just facilitated buyers and sellers. That is now changing since Alibaba bought a large logistics company and has begun warehousing some items. This will put them more in step with the Amazon model. Also like Amazon, the company offers cloud services in China and has begun investing in online entertainment, much like Amazon has in the U.S.

Revenues have been growing at an annual average of 57.6% over the last three years. For the 2015 fiscal year, which ended in March, revenue was up 43.4% to $12.3 billion. Operating income was $4.1 billion. The company has $20 billion in cash and 8.5 billion in debt.

The company's mobile business is growing dramatically as well, with 673 million mobile users. Keep in mind that China is in the very early stages of Internet commerce and penetration amongst the entire population currently is at 47.9%. That compares to the U.S., which is at 74.4% of households. Of course there are a lot more households of China, which has a population of 1.3 billion compared to 321 million in the U.S.

China is a very different retail market than we are used to. The availability of bricks and mortar stores is much more limited than in more developed countries. So to get the selection and quality of goods they want, Chinese consumers have little choice but to go online, to a large degree bypassing the mall economy that we built in North America.

So why does Barron's dislike Alibaba? First, they are concerned about growth beginning to slow and the macro problems in China. Those may or may not be as dire as we fear but certainly something isn't going quite right in China in terms of economic growth. Second, the journal points to increasing competition from JD.com, which bills itself as China's largest online direct sales company, and others. Barron's is also concerned about the confusing corporate structure and possible conflicts of interest that might result from that. For the record, Alibaba disputed the analysis in a public letter, saying the Barron's article "contains factual inaccuracies and selective use of information."

One of the main reasons for the complicated corporate structure is the Chinese restriction on foreign ownership of certain types of assets. The Alibaba structure is not unique but it is certainly more convoluted than we would feel comfortable with in North America.

None of these concerns are trivial and as a result the shares of the company have been getting hit very hard, as I mentioned at the outset. But at the end of the day, we are looking at the second largest global economy with a massive and growing population of new consumers who are rapidly adopting Internet commerce and mobile applications. Additionally you have a dynamic CEO who is driving towards two billion users globally, with the financial firepower and passion to make it happen.

The company is covered by a number of analysts, most of whom still have a buy rating albeit with reduced targets in the high $90s. This is certainly not a stock for your kid's college fund or for widows and orphans but at some point it will find a bottom and when it does there will be an opportunity for a dramatic rebound.

As I said at the beginning, this is an aggressive, contrarian recommendation of a type that we don't often feature in this newsletter. But I like the company's prospects. China isn't going away and neither is e-commerce. BABA is the best overall choice to benefit from this dramatic trend. I would suggest that aggressive investors average in over the next month. Alternatively, you can monitor the stock closely and take a position when a base begins to form.

Action now: Buy with a target of $80. The stock closed on Friday at $59.24.

Disclosure: I am/we are long BABA.