Alibaba Group Holding Ltd (NYSE:BABA) leads the Chinese online retail market. If it can continue to dominate there, it will become one of the world’s largest and most important enterprises in due time. However, BABA stock suffered turbulence after its IPO. Alibaba lost more than half its value, plunging from around $120 into the $50 area.
Although it has regained momentum in 2016, and a strong earnings report last week sent shares flying higher, investors need to question whether there is more upside ahead, or will concerns about the company drag BABA stock back into the depths.
Alibaba: Three Pros
The Next Amazon? The bull case for BABA stock is clear, and easy to understand. Alibaba is shaping up to be the next Amazon.com, Inc. (NASDAQ:AMZN). And, in contrast with Amazon, Alibaba has a much larger addressable market. Making things even better, the Chinese economy is growing far more rapidly than the U.S. Consumer spending is accelerating at rates no longer possible in the U.S., offering a huge lift for Alibaba if it can retain its dominant position in the Chinese market.
Growth Reaccelerating: Year-over-year revenue growth for the June quarter shot back up to 59%. The company sported 54% revenue growth at the time of its IPO, but quickly slumped, and revenue growth dipped to below 30% annually.
As revenue growth slowed, BABA stock went with it. If the model is correct and Alibaba is China’s Amazon, then growth is the single most important metric for BABA stock. If Alibaba shares Amazon’s imperial spirit, crushing all competition in its path, BABA stock will almost certainly sprint higher.
The growth slowdown shook confidence in Alibaba’s growth story, and BABA stock slumped more than 50% with it. However, with growth now the fastest since the firm’s initial public offering, it wouldn’t be shocking to see shares move to new all-time highs too.
JD.com Fading: Alibaba’s clearest domestic competitor is JD.Com Inc(ADR) (NASDAQ:JD). When JD arrived on the U.S. market, it appeared it would be a significant threat to Alibaba’s dominance. However, JD lost power fairly quickly. Shares peaked just shy of $40 last year. Since then, the shares have lost half their value, and have only recovered a bit. Unlike BABA stock, JD hasn’t made any big push back toward all-time highs.
At a $37 billion market cap, JD.com isn’t small. It’s No. 2, and it’s a significant player. It has connections with important firms, including Wal-Mart Stores, Inc. (NYSE:WMT). However, it is only growing revenues at 42%, significantly behind Alibaba’s pace. For the No. 2 player to steal the leader’s advantage, it has to grow much more quickly than the top dog. JD is not performing badly, but it hardly looks like the threat that Alibaba short sellers talked about last year.
BABA: Three Cons
Other Businesses Are Soft: Alibaba earns strong returns from its core retail business; its commerce division earns fat 61% EBITDA margins; however, the cloud computing business losses money on an EBITDA basis. And the digital media and innovations segments run huge losses. Overall, Alibaba earns just a 43% EBITDA margin, far less than it would if it only operated its core business.
The cloud business is making progress, and it may become profitable over the next year or two. But, overall, bears can make a solid case that Alibaba’s other ventures are not adding a lot to the company’s valuation. The Alibaba-as-Chinese-Amazon mental model can cause harm in this instance. Amazon is doing well with many of its ancillary businesses, thus it is easy to assume that Alibaba will have similar success. But there’s currently little concrete evidence supporting that notion.
SEC Investigation: BABA stock slumped 7% in one day earlier this year following news that the Securities and Exchange Commission is investigating the company’s accounting practices. In particular, the SEC saw potential trouble with two issues.
One of these issues is how Alibaba consolidates revenue with its logistics partner Cainiao. Alibaba only owns 47% of the firm, and thus only consolidates roughly half of Cainiao’s losses onto its own income statement. However, since Alibaba effectively controls the firm, it perhaps should post all the losses on its own consolidated financial statements.
The second accounting concern is potentially more troubling. The company’s reported revenues for its Singles’ Day promotion include all gross revenues. However, it is estimated that 20% to 30% of these revenues weren’t real.
Instead of real sales, sham transactions allegedly occurred in which sellers made fake sales to boost their marketplace vendor rankings. By reporting gross revenues rather than the lower and truer figures, Alibaba is perhaps offering too rosy a picture to investors. Neither of these issues by themselves should be showstoppers.
However, bears have long questioned the company’s accounting practices. An official SEC investigation adds fuel to the supposed fire. Even if everything turns out clear, the smoke clouds the bull case for BABA stock.
Fraud Risk: Tied into the SEC investigation and accounting concerns, we can’t overlook the fact that notable people have suggested there are dark doings at Alibaba. Jim Chanos, the famed short seller who almost single-handedly exposed Enron, declared that Alibaba’s accounting is nearly as opaque as Enron’s was.
And that’s not all.
John Hempton, hedge fund operator and prominent financial blogger, suggests that Alibaba is overstating its results. In one post, he showed how at more than $1,000 in sales per Chinese user per year, Alibaba supposedly earns 40% of the average Chinese household’s consumer spending annually. That seems high.
In another post, he argues that Alibaba’s Singles’ Day promotion seems implausibly big. The company claims to fulfill 278 million orders for Singles’ Day. Amazon, by contrast, only fulfills 37 million orders for Cyber Friday.
It seems questionable that Alibaba is really moving 8x as much inventory in one day as Amazon does on the biggest online shopping day of the year in the U.S. Hempton has previously exposed other fraudulent Chinese firms, and shouldn’t be dismissed lightly.
The Bottom Line on BABA Stock
For me, this stock is a clear no-go. However, I built my career exposing fraudulent Chinese companies during the reverse merger craze a few years ago, so I must admit bias. I don’t accept questionable accounting, and that is doubly true when the firm in question is located in China.
If you are more tolerant of hazy financial statements, BABA stock may be a buy here. The company is picking up momentum and a move to retest and potentially break through the all-time high seems reasonably likely. However, watch BABA stock like a hawk if you own it, it’s a risky name.
As of this writing, Ian Bezek was long WMT. You can reach him on Twitter at @irbezek.
