In the last month, several major developments occurred within China, which would have wide implications for the country’s private sector and Alibaba (NYSE:BABA) in particular. First of all, Beijing’s decision to fully pivot on its zero-Covid policy could lead to the improvement of the country’s consumer confidence, which coupled with various government stimulus packages could spur the growth of the economy and help Alibaba’s core commerce business to recover. At the same time, Xi Jinping’s decision to start repairing China’s ties with the West by reshuffling Beijing’s diplomatic corps and adopting a more moderate approach on how to conduct relations with Washington and others also has an opportunity to ease the tensions between the great powers and encourage foreign investors to once again invest in China.
However, there are several fundamental reasons to believe that despite all of those developments Chinese stocks and Alibaba in particular would continue to be uninvestable for foreigners in the long term. I have already explained several of those reasons in my latest articles on the company, and while Alibaba’s stock managed to slightly recover in recent months, it still trades significantly below its all-time highs and there are reasons to believe that the upside from the current levels is minimal due to various forces that are outside of its control. At the same time, while the stock could slightly appreciate even more in the short term as investors await the Q3 results that should be released in a few weeks, this article will highlight the additional challenges that the company would continue to face despite the developments that are happening in Beijing.
Change Is Coming
After the Chinese economy began to decline while the protests that opposed movement restrictions started to gain traction, Beijing decided to change course and abandoned its zero-Covid policy overnight. While some movement restrictions remain, it’s safe to say that they won’t have the same negative effect on the Chinese economy in comparison to the wide lockdowns that occurred in China in 2022.
This is definitely a positive development for Alibaba, which in recent months experienced a decline in its core commerce business and decided not to report the sales from the Singles’ Day event for the first time as consumer confidence cratered. The decline of the company’s earnings in Q1 and Q2 in dollar terms shows how Beijing’s policy has damaged the company’s business and destroyed additional shareholder value. However, as Beijing aims for growth and is reopening the economy, there are reasons to be positive about the performance of Alibaba’s core commerce business in the following months.
At the same time, in addition to the change in economic policy, Beijing has also decided to reshuffle its diplomatic corps, which signals the need to seek closer cooperation with the outer world. Last week, Financial Times published a big piece on China’s new approach to foreign policy and the need to repair broken ties with the West. The article highlights the efforts that Beijing takes to distance itself from Russia after the latter’s failed conquest of Ukraine and to win back friends in Europe and Washington.
The appointment of the former ambassador of China to the United States Qin Gang for the role of a new minister of foreign affairs earlier this month is one of the clearest signs that Beijing is looking to return to the pre-Covid foreign policy. Under that policy, Beijing has been deepening its engagement with the outer world on its own terms while at the same time carefully managing Western red lines to win friends in major capitals. The publication of Qin Gang’s opinion piece in the Washington Post in which he advocates for stable Sino-American relations coupled with the demotion of prominent wolf warrior diplomats and the upcoming European tour of the former foreign minister and the current Politburo member Wang Yi indicates that Beijing is striving to ease the tensions between great powers.
All of this is important for Alibaba for two major reasons. First of all, even though PCAOB reported that it has gained full access to the books of Chinese firms, the committee still hasn’t released a report about its inspections while the legislators decreased the time under which Chinese firms could be forced to delist in case of non-compliance. A potential improvement in relation thanks to Beijing’s new foreign policy could ensure that the threat of delisting would be fully neutralized in the next couple of years.
Secondly, Alibaba’s cloud business along with its computing systems rely on chips designed by Nvidia (NVDA) and Intel (INTC). The latest export control rules implemented by the White House have all the chances to disrupt Alibaba’s cloud computing and AI projects while additional export controls could fully cut the company from receiving any advanced western chips at all making it impossible for the company to scale its cloud business. The Dutch government in compliance with the U.S. rules has already prohibited its national champion ASML (ASML) from exporting any advanced EUV lithography systems to China preventing the latter from building its own advanced semiconductor fabrication plants that are needed to build advanced chips. A potential improvement of relations could at least give Alibaba some time to look for alternatives or design and produce its own chips in local plants that might not be as sophisticated in comparison to Western chips but could at least help its cloud business to remain afloat.
Last but not least, in addition to the economic and foreign policy changes Beijing has finally approved a $1.5 billion capital increase for Ant Group in which Alibaba holds a 33% stake. The approval coupled with the news that Jack Ma has given away the majority control of Ant Group last week were positively viewed by the market and helped Alibaba’s stock to slightly appreciate. While it would be premature to talk about a full easing of grip by Beijing, it appears that the Ant Group saga that lasted for over two years and cost shareholders billions of dollars of lost value is coming to an end. As a result, Alibaba’s bulls could finally take a breather and not worry about potential major interferences in the company’s affairs by Beijing in the next couple of months.
Can Alibaba’s Business Actually Recover?
There’s a case to be made that Alibaba’s core commerce business could receive a short-term boost from the abandonment of the zero-Covid policy, which was mostly responsible for the business’s poor results in the past. The street has already revised Alibaba’s revenue forecast for the current fiscal year. If a couple of months ago the consensus was that Alibaba’s revenues would decrease by 3% in FY23, then the current consensus is that the company’s revenue would now increase by 2.5% for the same period mostly thanks to Beijing’s decision to abandon the zero-Covid policy.
However, it’s still too premature to talk about the possibility of returning to the aggressive pre-Covid growth rates. As one of the biggest Chinese companies, Alibaba’s growth is likely to be dependent on the overall state of the country’s economy. Considering that China’s economy has grown by only 3% in 2022, below the earlier official target rate of 5.5% which was already the lowest in decades, it’s safe to assume that it would be harder for the company’s business to show exceptional results in the foreseeable future. Even though the local governments are aiming for an over 5% growth rate in 2023, such a growth rate is still lower in comparison to pre-Covid rates. Add to this the fact that home prices in China continue to decline despite various stimulus packages while the health system could be in a state of collapse due to the sudden change of health policy and it becomes obvious that even an over 5% growth rate is not guaranteed in 2023.
At the same time, China’s digital yuan continues to gain ground with the help of China’s central bank and slowly takes over Ant Group’s Alipay market share in the payments business. I’ve already explained in one of my latest articles on Alibaba that it’s likely only a matter of time before the company won’t be able to rely on profits generated by Ant Group to improve its bottom-line performance and keep the street excited about the business’s overall future. This would undoubtedly have a negative effect on its overall performance.
A similar thing is true about Alibaba’s cloud business. As it was noted above, the company’s cloud business is not growing as aggressively in comparison with its Western peers and potential additional export controls could greatly disrupt Alibaba’s cloud business even more, leaving the overall business without any major options to hedge itself in case of a weak performance of the core commerce business in the future.
With all of this in mind, it’s safe to say that after a recent rally of Alibaba’s stock, which was made possible mostly thanks to the actions of Beijing, the upside appears to be limited at the current levels. My latest DCF model which was created after the Q2 earnings results were revealed in November showed that Alibaba’s fair value is $115.71 per share. The latest appreciation of Alibaba’s shares already helped the business to reach that level and as a result, it appears that there’s no major upside going forward. Even though the street has revised its forecast for FY23, the growth in the following years remains to be in-line with the previous estimates which suggest that the stock trades around its fair value with little margin of safety. I’ll certainly update the model after the Q3 numbers come out next month to see whether the assumptions in the model are far from the reality or not.
What’s Next?
From a fundamental point of view, Alibaba trades at its fair value and doesn’t have a significant upside at the current levels. However, it’s likely that due to Beijing’s pivot on the economy and foreign policy, the stock could keep its momentum and appreciate above the fair value level in the short term after years of losing value and disappointing its shareholders. The potential short-term catalysts could be a positive report from PCAOB and a better-than-expected performance of the Chinese and global economy in 2023.
However, as I’ve noted numerous times, the movement of Alibaba’s stock depends on the mood of officials in Beijing and Washington D.C. The constant pivots by Beijing could also lead to a significant loss of value of Alibaba’s stock, as was the case for more than two years when the government began the crackdown against the domestic tech sector and started to interfere in its affairs. At the same time, the potential implementation of new export restrictions that are currently being discussed could easily create additional downside pressure for Alibaba’s stock.
Add to this China’s population decline, the potential invasion of Taiwan, the VIE loophole that could be closed at any time, the lack of capital inflows into Alibaba’s stock by major institutional investors, and the news that the Cyberspace Administration acquired golden shares in some of its businesses and it becomes obvious that Alibaba is uninvestable for long-term investors. As a result, I stick to my opinion that it’s better not to expose your portfolios to China as the ongoing bifurcation of the global system is likely going to lead to more disruptions in the future and would overshadow any Chinese growth catalysts in the following years.
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.
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