Eager for desperately needed positive news, Chinese e-commerce giant Alibaba Group Holding Ltd (BABA) has reportedly put up $5 million to $10 million to help fund Israeli startup Twiggle. Specializing in focused search engine technologies, it’s hoped that Twiggle can further advance Alibaba’s aggressive expansion efforts.
However, Alibaba investors may need much more to be impressed. Over the past two months, BABA stock has gained 4%. More critically, an investigation by the Securities and Exchange Commission into accounting practices ensures that Alibaba will have anything but an uneventful year.
Truth be told, Wall Street has long suspected financial irregularities as a major risk factor for BABA stock. Renowned activist investor Jim Chanos has even gone so far as to short Alibaba stock purely on the basis of “accounting concerns.” For insiders, the SEC merely confirmed a commonly believed conspiracy.
But to the general public, this crystallized fears of a lack of transparency in Chinese markets. On May 25, the day that Alibaba disclosed the SEC investigation, BABA stock fell 7% — the worst single-day performance of the year so far.
Is the Ride Over for BABA Stock?
At the same time, it’s unlikely that accounting irregularities alone will sink Alibaba stock.
There are two main points of interest for the SEC — sales data of the company’s “Singles’ Day” promotion, and profit-booking practices of BABA affiliate Cainiao Network.
For the latter, Alibaba owns 47% of Cainiao, drawing questions about whether it should entirely consolidate the logistics specialist — and therefore book 100% of profits or losses. In the former case, there’s suspicion that BABA users artificially inflated their sales tally through buying their own goods. In both situations, the issue is accounting accuracy, not outright fraud.
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There are two ways to look at this.
Alibaba is one of few mega-capitalization companies consistently churning out double-digit revenue growth. However, the days of delivering monstrous, triple-digit growth is evidently over. The past two years have produced top-line sales gains averaging 35%. That’s not bad at all until you compare it to the 70% growth seen between 2007 and 2013.
The other challenge is that it’s only going to get harder from here on out. Alibaba already has a massive share of the Chinese consumer market. In order to see further growth in valuation for BABA stock, the company would have to beat out its competitors and deliver bonkers-level revenue.
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If statistics from The World Bank prove accurate, BABA stock will have even more problems in the near future. The East Asia and Pacific region is expected to produce aggregate GDP growth of 6.3% in 2016, and then drop to 6.2% over the following two years. This aligns with broad weaknesses already reported among the emerging markets.
In addition, potential Alibaba stock buyers will have to contend with a harsh reality — the company’s core business is not unique. This is reflected in the fact that cost of goods relative to revenue generation keeps rising.
In other words, BABA stock is less profitable against gross margin.
In and of itself, that’s not a red-flag issue. However, it indicates that Alibaba lacks the leverage to charge more for their services. That means the company will have to directly duke it out with its rivals within a consistently shrinking market.
And don’t forget that Softbank is now selling a part of its own stake in BABA — to the tune of at least $7.9 billion.
Alibaba has been catching a lot of unwanted press, and BABA stock has borne the brunt of the damage. Nevertheless, the SEC investigation at this time gives off the impression of being a high-level distraction.
The bigger headache for BABA management is sales. After dominating the Chinese retail market in quick fashion, there are fundamental concerns of meeting lofty expectations. Ultimately, the success of Alibaba stock will hinge on finding the solution.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
