Alibaba Stock: Is The Panic Justified? (NYSE:BABA)

Article Thesis

Alibaba (NYSE:BABA) has seen its shares drop by more than 10% on the news that its shares might get delisted. Delisting is far from certain for now, and even if shares were to be delisted, that would not hurt the underlying value of the company. Less liquidity may be an incremental negative, but that does not warrant a market cap decline of $30 billion.

Since Alibaba already was priced for disaster even before that recent price drop, the current market price looks overly bearish, which provides a buying opportunity for enterprising investors.

What Happened?

Alibaba has seen its shares drop by double-digits on the back of a news item that Seeking Alpha summarized like this:

Alibaba shares fell as much as 10% Friday [more as the day progressed] after the U.S. Securities and Exchange Commission added the Chinese Internet and e-commerce giant to its list of companies facing possible delisting from U.S. stock markets.

The SEC had been working on delistings for some Chinese companies for some time, and some of these companies have already been delisted in the past. July 2022 was not the first time the market worried about a potential delisting. In fact, BABA’s shares have dropped before on the back of a potential delisting threat, such as in March 2022. A somewhat curious pattern has emerged where Alibaba drops by significant amounts from time to time when delisting fears are rising, but shares never seem to trade up by double-digits on the news that the company has not been delisted so far.

Delisting: Threat Or Not?

No matter what, the market has once again found an opportunity to sell off this already very inexpensive stock. But is the market panic really justified based on what we know right now? I do not think so. First, the fact that the SEC has now included Alibaba on a list of companies that might get delisted at some point does not mean that delisting is a sure bet. More importantly, even if Alibaba were to be delisted, I do not see a reason why this would justify a $30 billion destruction in market value, as the underlying value of the company should essentially be the same, listed or not.

Let’s get to the first point first. As mentioned above, this is not the first time delisting rumor have emerged. And yet, they never did result in delisting in the past. This time may be different, but history suggests that some news item that hints at a potential delisting does not automatically lead to a delisting later on — far from it, in fact. Also, Alibaba has made clear that the company will eagerly fight against a potential delisting. The company stated it would strife to keep its New York listing. That does not guarantee that the company will be successful, but the fact that management is eager to tackle this issue is good news for investors that are worried about a potential delisting. The SEC’s main issue with Alibaba and the other Chinese companies that might get delisted at some point in the future is the fact that US officials can’t review the work of the auditors of these companies. This is due to a Chinese law that prohibits said practice. In general, Chinese politicians/regulators could change their policy in order to allow US regulators to check the work of these auditors more easily. But at least for now, China has not done any such move. If the country came to the conclusion that a US delisting would hurt Alibaba in the long run, I do believe that they would make changes to their policies, as a strong and profitable BABA is in China’s interest both from an economic as well as “tech power” point of view. The fact that China seemingly is not worried about a US delisting of its top tech companies suggests to me that either or both of the following are true:

1: China believes that the US will not delist Alibaba anyways, even if China does not change its policy of hindering US overwatch for Chinese auditing.

2: China believes that a US delisting is possible, but that said delisting would not hurt Alibaba meaningfully.

I do believe that delisting is far from guaranteed, but it can’t be ruled out. Chinese (and US) officials will most likely have more intimate knowledge and will likely be able to ascertain the likelihood of delisting more precisely.

But I do believe that delisting would not be a major threat for Alibaba, even if it happens. After all, BABA being delisted in New York does not mean that investors will lose their stake in the company — nor will it mean that the company will be less profitable. When a stock gets delisted, which is a process that happens regularly for all kinds of reasons, then these shares are not untradeable. Instead, they are traded over the counter (‘OTC’), which means that a dealer network is used instead of a stock exchange. I have invested in stocks that are traded over the counter in the past and do also currently hold some, and the process of buying and selling shares isn’t all that different. In fact, it’s a pretty similar process, with spreads being slightly larger on average. Especially with larger companies, spreads generally aren’t an issue, even when they are traded over the counter. LVMH (OTCPK:LVMUY) is such an OTC-traded international giant, and the fact that it’s traded over the counter has not hurt investors — daily volume is still in the $30 million range, thus liquidity isn’t an issue here at all. Roche (OTCQX:RHHBY) and Tencent (OTCPK:TCEHY) belong to that group of OTC-traded large international companies as well, and liquidity isn’t a concern for them, either. I do believe that the same would most likely hold true if BABA were to be delisted at some point in the future.

I’m a fundamental investor, so I believe that the underlying value of a company’s shares depends on factors such as cash on the balance sheet, profits, cash flow, and how those change over time. Most on this website will agree with me, I believe. These metrics aren’t impacted by a potential delisting — Alibaba will remain just as profitable, its cash flows will be the same, and its equity investments and cash position will not fall either, even if there were to be a delisting. Buybacks and potential dividends (at some point in the future) are also not dependent on a New York listing.

I do thus believe that delisting is far from certain. In fact, all the potential delisting news we got in the past has not resulted in a delisting so far, and the same may hold true for the current round of delisting panic as well. And even if Alibaba were to get delisted, it wouldn’t be the end of the world. Instead, the underlying value of the company should essentially remain the same, as profits, cash flow, etc. are not impacted. And investors would still be able to buy and sell stock relatively easily, and thanks to BABA’s large size, liquidity shouldn’t be an issue — it’s not an issue for other OTC-traded large companies, after all.

Priced For Disaster

Following the most recent price drop, Alibaba is now trading at just 12x this year’s expected net profit. Amazon (AMZN), its closest US peer, is trading at 980x net profit right now. Amazon’s stronger international brand and its US location do justify a premium, but should it be this large? Or, in other words, should BABA trade at a discount that is this immense? I do not believe that this is necessary.

Alibaba also looks very inexpensive when we look at its enterprise value to EBITDA multiple. That ratio stands at 8.5 right now, which is pretty low in absolute terms. On a relative basis, BABA looks even less expensive, as the 5-year median EBITDA multiple of the stock is 25 — in other words, BABA trades at roughly one-third of its historically “normal” valuation right now. That does not mean that its shares will rise by 200% in a short period of time in order to get back to the longer-term average valuation. But buying a stock at 34% of the usual valuation naturally results in a solid risk-reward setup. Multiple expansion from the current level seems way more likely to me than further multiple compression.

Takeaway

Delisting news and rumors have always resulted in volatility for BABA. But in the end, I do believe that this is an overblown issue. Alibaba’s worth as a company does not depend on a New York listing, and its cash flow and profit do not, either. Investing in OTC-traded stocks works just fine, thus even if BABA were to be delisted (which is far from guaranteed), investors could still buy and sell shares easily.

Alibaba is very inexpensive today, and its growth has not been bad in recent quarters. Growth has come down compared to the longer-term average, but that is partially the result of tough comparables — Amazon and other e-commerce players outside of China face the same issue, and yet they trade at way higher valuations than Alibaba.

Alibaba isn’t a risk-less investment for sure, and trade issues or a potentially escalating China-Taiwan conflict would be macro risks to consider. But the recent sell-off that was caused by news about a potential delisting seems overblown. Markets are in panic mode, but I do not believe that this is justified. Alibaba could be a compelling longer-term investment at the current priced-for-disaster valuation.