Alibaba Stock: Beijing Strikes Back (NYSE:BABA)

The decline of Alibaba Group Holding Limited’s (NYSE:BABA) share price in recent quarters was more than expected. Once Beijing started to indirectly interfere in the company’s affairs by issuing fines and implementing different restrictions that make it harder for China’s biggest tech behemoth to improve its top and bottom-line performances, the depreciation of its stock was only a matter of time. Alibaba’s disastrous performance in Q3, in which its revenues grew less than anticipated, signals that the period of unprecedented growth that the company has experienced before is long gone, especially considering the fact that there’s no indication that Beijing will stop interfering in its affairs anytime soon.

As a result, I continue to believe that Alibaba is a poor investment even at the current price. In recent months, I’ve been warning investors that it makes no sense to use conventional valuation methods to value Alibaba and find the best entry point since the shift in Beijing’s policy regarding its regulation of the private sector will only lead to the materialization of additional key risks, which will hurt performances of country’s tech firms. Given the fact that Beijing continues to crack down on its businesses and implement new rules, the goal of this article is to expand my thesis, point out why the bulls are wrong, and argue why Alibaba shareholders shouldn’t expect any meaningful returns anytime soon.

The Pressure Is Real

The major mistake of Alibaba’s bullish investors is the fact that they continue to use traditional valuation methods to justify a long position in the company. The problem is that, while it’s true that Alibaba trades cheaply, especially in comparison to its Western peers, the environment in which the company operates has been changing since late 2020. The tech crackdown that started in recent years is far from being over and the latest actions of Beijing signal that more regulations are coming. As a result, by being one of the biggest tech behemoths in China, Alibaba will be affected the hardest by the upcoming changes, which could potentially create more selling pressure for its stock in the following months.

The latest earnings report for Q3 showed the negative effect that Beijing’s new regulations had on Alibaba. During the three-month period, the company managed to increase its revenues only by 10% Y/Y to $38 billion, below the estimates by $520 million. At the same time, after losing its status as a key software enterprise in China, Alibaba’s effective tax rate dramatically increased from 10% before to 33% in Q3. As a result, the company’s net income decreased by 75% Y/Y to $3 billion during the period.

Considering such a weak performance, I don’t see how Alibaba will be able to return to aggressive growth and significantly improve its bottom line performance anytime soon. As Xi Jinping prepares to secure another term as the chairman of the Communist Party of China next year, the implementation of his common prosperity policy is vital for his reelection. As a result, investors should expect further consolidation of industries and more regulations to follow.

In my recent articles on Alibaba, I’ve already explained how Beijing is slowly taking away the cloud and digital payment businesses from the tech firm’s hands. There is every reason to believe that it’s only a matter of time before new risks begin to materialize, creating additional selling pressure on BABA stock.

What’s Next?

In the past, Alibaba has thrived in an environment in which the state didn’t interfere in its affairs. As the environment in which it operates is changing, it’s hard to see how it will successfully adapt to it given the constant pressure from Beijing. Last month it was revealed that China’s political establishment has been pressuring regulators to create new laws for the tech sector, which could signal that the crackdown is not over yet. In mid-February, Beijing once again interfered in the private sector by indirectly forcing a food delivery company Meituan to lower its delivery fees, which will have a negative effect on its earnings. Alibaba also has its own food delivery service Ele.me, so it won’t surprise me if Beijing orders the company to restructure its business model and sacrifice profits as well.

In addition, the new algorithm rules went into effect on March 1 and could hurt Alibaba as well, given the fact that a large chunk of its revenues is generated by running digital ads for merchants across its ecosystem of products. On top of that, as Alibaba starts to enter the metaverse space by flooding it with investments, China’s latest 2022 Two Sessions has been actively discussing the implementation of new regulations in the space to expand its control over the new medium. Considering all of this, it’s hard to see how Alibaba will be able to improve its top and bottom-line performance in the following quarters in this strictly regulated environment.

In addition to the negative effects of Beijing’s new policy, Alibaba is also likely going to suffer from the slower growth of China’s economy this year. Due to the war in Europe along with the resurgence of Covid-19 in China, the country’s officials target a 5.5% economic growth in 2022, the lowest in decades. However, different investment banks and advisory firms believe that the growth rate will be even lower, making it even harder for China’s biggest tech behemoth to once again show solid results. In Q4, the street expects Alibaba to increase its revenues by only ~12% Y/Y to $32.51 billion, while its normalized earnings per share are expected to stand at $1.41. For comparison, a year ago Alibaba’s FY21’Q4 revenues increased by 81% Y/Y, while its EPS stood at $1.60.

Considering this, bullish investors are fooling themselves when they say that Alibaba is on a growth trajectory. The latest developments clearly show that its performance has been relatively weak in comparison to previous years when Beijing wasn’t interfering in its affairs. In the last three quarters alone, the company has missed streets’ revenue outlook and there’s every reason to believe that the same will happen in Q4, as it clearly shows that Beijing won’t back off and will continue to implement new rules and regulations, which hurt Alibaba’s business.

Counterarguments

The comments sections of my articles on Alibaba are constantly filled with Alibaba bulls, who have been highlighting some interesting ideas about why I’m wrong on this stock. While Alibaba’s stock has depreciated by over 20% since I started to cover the company in early October, I do think that there’s a slim chance that several things could push the price higher in the short to near term. First of all, after the massive depreciation in the last few weeks, China has officially stated that it plans to support its companies that are listed overseas. That statement alone helped Alibaba and other Chinese stocks to greatly appreciate.

Considering this, it’s safe to say that any possible positive statement in the future from Beijing could help boost Alibaba’s stock. The problem is that most of Beijing’s latest actions did more harm than good to Alibaba and its peers. However, you can never underestimate the power of positive statements by government officials.

In addition, due to the slower growth of China’s economy and upcoming party elections, there’s also a possibility that Beijing eases its grip over tech firms for a while to stimulate growth in the short term. This could help Alibaba to breathe more freely and, along with its $25 billion buyback plan, create buying pressure. This could lead to a rebound in its share price in the short-term and undermine my thesis.

The Bottom Line

Alibaba is no longer the growth story that it used to be. While its stock trades at less than 3 times its sales and could be considered a bargain at the current price, the external factors that negatively impact its business are making it hard to justify a long-term long position in the company.

Let’s not forget that Alibaba has been trading at distressed levels for over a year already and yet no buying pressure has been created that could’ve helped its stock to significantly appreciate. In fact, the opposite has happened as institutional investors started to dump their holdings in Alibaba fearing more interference from Beijing, which has created even greater selling pressure on the company’s stock. Given the fact that there’s no indication that Beijing has eased its grip over the tech sectors, I continue to believe that Alibaba is still a poor investment at this stage and should be avoided until the situation changes.