Alibaba: Uncovering The Risks And Rewards (NYSE:BABA)

Alibaba Group: Proceed with Caution

Alibaba Group (NYSE:BABA) was once a darling of value investors, but after the regulation fears, the disappearance of Jack Ma, and people realizing what investing in China is really like. The risks associated with the Chinese Communist Party (CCP) and a communist regime in general were grossly underestimated in 2020 and 2021.

I believe Alibaba is a wonderful company with strong financials, but the risks around this company are just too high at the moment. This is why I currently rate this business as a HOLD.

A Leader in Online and Mobile Commerce

Alibaba Group Holding Limited is a Chinese multinational technology company that operates a marketplace, shopping search engine, cloud computing, and other technology and e-commerce-related services.

The company was founded in 1999 by Jack Ma and is headquartered in Hangzhou, China. Alibaba’s main business is the online and mobile commerce platform, which allows companies and individuals to buy and sell products and services online. The company also operates a number of other businesses, including a cloud computing platform, a digital media and entertainment unit, and a research and development arm.

Why Alibaba Group is a Strong Investment Opportunity

Alibaba would be a strong investment if not for the risks associated with it, due to its strong financial performance and growth potential. The company has consistently reported strong revenue and earnings growth, driven by the growth of its e-commerce platform and other businesses. This strong financial performance is expected to continue as the company expands its e-commerce platform into new markets and invests in new technology.

Alibaba is also well-positioned to take advantage of the growing trend of online shopping and e-commerce in China and internationally. The company’s e-commerce platform, Alibaba.com, is the largest in China and the company is expanding into new markets, including Southeast Asia, the Middle East, and Latin America. This expansion is expected to drive further revenue and earnings growth for the company.

In addition to its e-commerce platform, Alibaba also operates a number of other businesses that are expected to contribute to the company’s growth. These include a cloud computing platform, Alibaba Cloud, which is the market leader in China and is expanding internationally. The company also has a digital media and entertainment unit, which includes music and video streaming services, and a research and development arm that is focused on developing new technology.

Overall, the investment thesis for Alibaba is based on the company’s strong financial performance, growth potential, and diversified business model. The company’s strong competitive position in the e-commerce market in China and its expansion into new markets and technologies are expected to drive further revenue and earnings growth in the future.

The Big Tech Crackdown

Further in this article, we will discuss the general risks of investing in China. This paragraph will discuss the effects of “The Big Tech Crackdown”. The Chinese government’s crackdown on technology companies began in November 2020, when Ant Group’s initial public offering was suspended. In the following year, other tech companies in China, including DiDi (DDIY), a ride-hailing company, and Meituan (OTCPK:MPNGF), a food delivery platform, have also faced regulatory action, such as app suspension and antitrust probes, respectively.

This has been referred to as the “Big Tech crackdown” in China and has included measures such as antitrust probes, data security overhauls, and a check on capitalist “excess.” These measures have targeted a wide range of sectors and have been carried out by various agencies, with varying justifications.

The crackdowns have been going on for two years already and wiped out at least $1.5 trillion in value from tech companies. The reasons for the crackdown are not fully clear, but some possible explanations include the Chinese government’s desire to assert its power over the tech sector, ensure that the data and wealth generated by tech companies does not challenge the party’s dominance, and address issues of data security and monopolistic behavior. Prior to the crackdowns, these large tech companies held significant influence, to the point where the Chinese Communist Party felt threatened by them.

Until October 2020, there appeared to be no major issues, as the tech companies were able to operate independently and the economy was thriving. However, the CCP wanted to demonstrate its own power and assert control over the tech companies. This event occurred following a speech by Jack Ma, the founder of Alibaba. In his speech, Ma criticized the Chinese government, which the authorities did not take kindly to. After this event, the Chinese government suspended the IPO of Ant Group as mentioned above.

After Chinese President Xi Jinping’s speech in 2021, which discussed the concept of “common prosperity,” which promotes the idea of moderate wealth for all and encourages the wealthy to contribute more to society, has become a central theme in many policy decisions. The rapid growth of the technology sector in China has exacerbated the issue of wealth inequality.

As a result, the Chinese government sought to curb the expansion of the sector, which some estimate was responsible for 30% of China’s GDP. As the dominance of tech giants such as Alibaba, Tencent (OTCPK:TCEHY), Baidu (BIDU), ByteDance (BDNCE), DiDi, and JD grew, it became a significant cause for concern that these companies may exert undue influence and accumulate disproportionate power, a prospect that has consistently vexed the Chinese government.

In response, authorities in China ramped up their enforcement of antitrust laws in 2021, imposing fines on a number of tech firms for breaching regulations and leveraging their market dominance to their advantage. These actions were intended to send a powerful message to the tech industry and the wider market, indicating that the Chinese government has no desire to see a concentration of wealth and power in the hands of a select few.

However, it appears that the regulatory crackdown is coming to a close, with the Ant Group reportedly resuming its IPO plans and receiving renewed support from the government. This shift is likely due to a combination of factors, including the weakening Chinese economy and public discontent over the prolonged Covid-19 lockdowns.

It is possible that the Chinese government has determined that the tech sector, and the companies that drive it, hold the potential to revitalize economic growth and alleviate the negative effects of the economic slowdown. As such, the authorities may have decided to loosen their grip on the industry, allowing these companies to operate with greater autonomy and potentially expand their reach.

We believe this is the case as it appears that the current state of the Chinese economy, mainly fueled by a declining real estate market, may be in a bad shape. Furthermore, we see a trend of individuals opting to leave their jobs, similar to the phenomenon of quiet-quitting observed in Western countries. This may be due to a growing sentiment among Chinese workers of being overworked and seeking a change in their employment circumstances.

Main Competitors

Alibaba’s main competitors in the e-commerce market in China include JD.com (JD) and Pinduoduo (PDD).

JD.com is a Chinese e-commerce company that operates a marketplace for a wide range of products, including electronics, home goods, and fashion. The company has a strong presence in China and is expanding internationally. JD.com differentiates itself from Alibaba by offering a direct sales model, where it owns the inventory and fulfillment of the products it sells, rather than operating a marketplace model like Alibaba. This allows JD.com to offer a higher level of quality control and customer service, but it also means that the company has higher costs and is less scalable than Alibaba.

Pinduoduo is a social commerce platform that offers discounted prices on a variety of products and is popular with price-sensitive consumers. The company uses a group buying model, where consumers can purchase products at a discounted price if they invite friends to join the purchase. Pinduoduo has grown rapidly in China and has gained a significant share of the e-commerce market, but the company is still smaller than BABA and JD.

In addition to its e-commerce competitors, Alibaba also faces competition from Tencent in the cloud computing and payments markets. Tencent is a Chinese multinational conglomerate with a strong presence in the technology, media, and gaming sectors. The company operates a cloud computing platform, Tencent Cloud, which competes with Alibaba Cloud in China. Tencent also operates a payment service, Tenpay, which competes with Alibaba’s payment service, Alipay.

Overall, Alibaba faces competition from a range of companies in the e-commerce and technology markets in China. While the company has a strong competitive position and a diversified business model, it is important for Alibaba to continue innovating and expanding in order to maintain its competitive advantage and drive long-term growth.

The Chinese Communist Party (CCP) holds significant sway over the success of companies operating in China. It is therefore critical for these firms to maintain positive relationships with the government in order to thrive. Poor relations with the CCP can significantly hinder a company’s growth and success. This is especially relevant in the case of Alibaba and its founder, Jack Ma, who have recently faced tensions with the government, potentially increasing the risk for BABA compared to rivals Tencent and Pinduoduo.

Valuation

BABA currently trades at a forward P/E ratio of 11.56, which is cheap compared to its main competitors, as can be seen in the table below.

Alibaba Group Holding Limited currently has a price-to-earnings (P/E) ratio of 11.56, which is significantly lower than that of its competitors. Furthermore, BABA’s earnings per share (EPS) of 7.51 is significantly higher than Pinduoduo’s EPS. These financial indicators suggest that BABA may be a more attractive investment compared to its competitors. Furthermore, other important financial metrics are looking solid as well as can be seen on the balance sheet. By example:

• FCF Yield: 6.18%, indicating that the company could buy itself back in 16 years, if it continues to provide this cash flow.
• ROIC: 11.95%, which indicates the company generates an additional $11.95 for every $100 it invests.
• Gross Margin: 36.5% TTM. Indicating that BABA remains to have decent pricing power in a competitive industry.
• Revenue 5-year annual growth rate Revenue (CAGR): 16.56%, this shows that BABA is able to continue its growth, even after all the tensions.

Alibaba’s Growth Potential: Opportunities and Risks

There are high expectations for Alibaba’s long-term growth potential, given the company’s strong financial performance and expansion into new markets and technologies. The company’s e-commerce platform, Alibaba.com, is well-established in China and is expanding internationally, which is expected to drive further revenue and earnings growth. In addition, Alibaba’s other businesses, such as cloud computing and digital media, are expected to contribute to the company’s growth.

One key driver of Alibaba’s long-term growth is the increasing trend of online shopping and e-commerce in China and globally. Alibaba is well-positioned to take advantage of this trend, as the company’s e-commerce platform is the largest in China and the company is expanding into new markets, including Southeast Asia, the Middle East, and Latin America. In these regions, there is a growing demand for online shopping and e-commerce, and Alibaba is well-positioned to capture a significant share of this market.

Another factor that is expected to drive Alibaba’s long-term growth is the company’s expansion into new technologies and businesses. Alibaba has made significant investments in research and development, and the company’s research and development arm is focused on developing new technologies that can drive growth. For example, Alibaba is investing in artificial intelligence, machine learning, and the Internet of Things, which are expected to be key drivers of growth in the technology industry in the coming years.

In addition to its e-commerce and technology businesses, Alibaba is also expanding into new areas such as digital media and entertainment. The company has a digital media and entertainment unit that includes music and video streaming services, and the company is expected to continue expanding in this area as demand for digital media grows.

Overall, Alibaba’s long-term growth is expected to be driven by the company’s strong financial performance, expansion into new markets and technologies, and diversified business model. The company’s strong competitive position in the e-commerce market in China, combined with its expanding presence in new markets and industries, is expected to drive significant revenue and earnings growth in the coming years.

There are, however, risks to consider when investing in Alibaba or any company, and it is important for investors to carefully evaluate these risks before making an investment. Some of the key risks to consider when investing in Alibaba include the regulatory environment in China, economic and political instability in the country, and currency fluctuations.

The regulatory environment in China can change rapidly and can have a significant impact on businesses operating in the country. For example, changes in regulations or policies related to e-commerce or technology could affect Alibaba’s business.

There is also the risk of economic and political instability in China, which could affect the overall business environment and the demand for Alibaba’s products and services. For example, the current recession in China will have an impact on the demand for online shopping and e-commerce, as we already saw by the small decline in revenue in Q3.

Risks Involved with Investing in China

It is important to carefully consider the risks involved when investing in Chinese companies, as these risks can significantly impact the share price. To protect against these risks, it is advisable to incorporate a larger-than-average safety margin into your investment thesis when investing in Chinese firms. This will help to mitigate the potential impact of any negative developments on your investment.

It is essential to thoroughly research and evaluate the specific risks that may be relevant to the particular Chinese company you are considering investing in. We will discuss some of the main risk in this paragraph.

Regulatory environment

The regulatory environment in China can change rapidly and can have a significant impact on businesses operating in the country. For example, changes in regulations or policies related to e-commerce or technology could affect Alibaba’s business.

For example, the Chinese government could implement new regulations that make it more difficult for foreign companies to operate in the country, or it could introduce new policies that affect the way Alibaba’s e-commerce platform operates.

Economic and political instability

There is also the risk of economic and political instability in China, which could affect the overall business environment and the demand for Alibaba’s products and services.

For example, if there is economic instability or a recession in China, it could impact the demand for online shopping and e-commerce. Similarly, political instability or social unrest could impact the overall business environment and the demand for Alibaba’s products and services.

Currency fluctuations:

There is also the risk of currency fluctuations, as the value of the Chinese currency, the Renminbi, can fluctuate against other currencies. This can affect the value of investments in Chinese companies for investors holding foreign currencies. For example, if the value of the Renminbi decreases against the US dollar, it could make Alibaba’s products more expensive for foreign customers, which could impact the demand for the company’s products and services.

Geopolitical risks:

Geopolitical risks are risks related to political and economic relations between countries that can impact businesses operating in those countries. When investing in China, there are a number of geopolitical risks to consider, such as:

1. Trade disputes: There is the risk of trade disputes between China and other countries, which could impact the demand for Alibaba’s products and services. For example, if there is a trade dispute between China and the United States, it could impact the demand for Alibaba’s products in the US, as well as the cost of importing goods from China to the United States.

2. Economic sanctions: There is also the risk of economic sanctions being imposed on China by other countries, which could impact the overall business environment in the country. For example, if economic sanctions were imposed on China, it could make it more difficult for Alibaba to conduct business internationally, which could impact the company’s revenue and earnings. Over the past several years, tensions between the United States and China have escalated, with the US imposing tariffs on Chinese imports that have directly impacted Chinese companies such as Alibaba, Pinduoduo, and Tencent. These tensions and trade actions can impact the financial performance and market value of these companies and should be considered when making investment decisions.

3. Political tensions: There is also the risk of political tensions between China and other countries, which could impact the overall business environment in the country. For example, if there are tensions between China and the United States over issues such as human rights or territorial disputes, it could impact the demand for Alibaba’s products in the United States, as well as the overall business environment in China. One potential example of how tensions between the United States and China could escalate is if China were to invade Taiwan. The US has long-standing commitments to Taiwan’s defense and has stated that it would strongly react to any attempt by China to invade the island. Such an event would have significant consequences for both countries and could potentially lead to further conflict.4. Geopolitical conflict: There is also the risk of geopolitical conflict between China and other countries, which could impact the overall business environment in the country. For example, if there is a military conflict between China and another country, it could impact the demand for Alibaba’s products and services, as well as the overall business environment in China. As stated above, Taiwan is a potential risk factor for conflict between the US and China. While it is unlikely that China will invade Taiwan in the short term, the threats and tensions between the two sides have increased in recent years and should be considered when evaluating the political and security risks for investing in China.

Technical Analysis

In the two years between late 2020 and October 2022, Alibaba experienced a significant downturn, with its value dropping by almost 82%. This is a significant decline for a well-established company like BABA. There are two key resistance channels that remain in place, which could potentially mark turning points for the stock.

A break above the longest of these channels could signal the end of the long downtrend that BABA has been experiencing. It may be worth keeping an eye on the $119.31 mark, which corresponds to a Fibonacci level, as seen on the 5-year chart. The immediate support level for BABA is around $80, but the more important level to watch is around $73.

On the long-term chart, the stock appears to be in a neutral position. It is unlikely that all-time highs will be reached in the near future, but if we see a breakout, the stock could potentially reach $120 or higher. This could be driven by improved market conditions and a more positive sentiment towards Chinese companies. It is important for the stock to hold the $57 level, which corresponds to the Covid-19 low. If this level is breached, there could be further downside, and the situation could become more challenging.

A Final Perspective

In conclusion, Alibaba is a strong investment for the long term due to its strong financial performance, growth potential, and diversified business model. The company’s e-commerce platform, Alibaba.com, is the largest in China and continues to expand into new markets. But, as mentioned in this article BABA is much more than that. They operate a number of other businesses. However, the company has faced regulatory concerns, the disappearance of its founder Jack Ma, and increased awareness of the risks associated with investing in China under a communist regime. As a result, the risks around this company may currently be too high for some investors, and it may be worth holding rather than buying at this time.

We believe that Alibaba could potentially be a good long-term hold if tensions between China and other countries ease. In the meantime, it may be best to hold onto any current positions in the company.

If you do not currently have a position in BABA but are interested in purchasing the stock, we believe that around the $60 support level (based on the technical analysis) would be an ideal entry point, as it provides a large margin of safety. We believe the $60 mark would price in most of the risk for this investment.

We would like to know your opinion on Alibaba. As a new author, we want to ensure that we have considered all relevant information and viewpoints in our analysis of the company. We welcome your thoughts and insights on BABA.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.