I confess up front that I am not much for momentum stocks, or stocks that get tons of media coverage that seem to be held up more by the media than the actual business. When it comes to companies like Alibaba Group Holding Ltd (NYSE:BABA), which are based in China, I am extremely wary of getting involved. Much of my wariness with Alibaba stock and other stocks like it are the inherent risks of doing business in China to begin with.
China is ultimately opaque when it comes to just about every aspect of business, regulation and government interference. The Chinese operate in a totally different world than we do. It’s easy to forget that this is a Communist dictatorship, so any resemblance to being a free-market capitalist economy is an illusion.
I’ve written this before, but it bears repeating, that the Chinese government wakes up each morning with one mission: how to clothe, feed and shelter two billion people. This concept filters down to every level of the bureaucracy. As a friend who does business in China tells me, a dentist convention in November might get cancelled without any reason given, because the boss of the bureaucrat in charge of that event just had a painful root canal and hates dentists.
BABA Stock Has a Big Problem
On Dec. 21, the U.S. Office of the Trade Representative issued a damning report about China and specifically BABA, which hurt Alibaba stock. As a part of the executive branch, the USTR is an agency that develops and coordinates international trade. The USTR specifically named the e-commerce platform of BABA, known as Taobao as one of the markets that is rife with “large-scale copyright infringement”. Indeed, counterfeit products of many American retailers have been found on the platform — as many as 131 brands.
In other words, there’s a ton of counterfeit goods on it. The report said, “Given the dominance of Chinese sellers on Alibaba’s platforms, it is critical that the Chinese Government support these efforts through measurable enforcement efforts across China and stronger domestic IPR reforms identified in previous Special 301 reports such as the development of its E-Commerce law.”
In fact, the report even identified Taobao as being a “notorious market” for such goods. That didn’t sit well with BABA stock.
Alibaba stock’s management has at least tried to show it takes the protection of IP seriously. In April, management launched Operation Cloud Sword. It allegedly led Chinese authorities to 417 counterfeit producers and facilities, in which over 300 people were arrested and $200 million of goods seized.
The problem for me, and any potential investors in BABA stock, is that we just don’t know how much of this story is even true. How much is PR? What is Alibaba really doing? How much counterfeiting is really going on and does BABA even know?
Bottom Line on Alibaba Stock
As close as Jack Ma may be to the Chinese government, what happens if one day they turn on him? Our relationship with China is going to change under the new administration. Suppose these counterfeited brands lobby the USTR and President-Elect Donald Trump, and they want China to crack down on Alibaba stock itself? Or for that matter, since BABA’s financials are ultimately opaque, what if the accounting issues that are already alleged turn out to be true?
All it takes is one big headline, and Alibaba stock could crater.
Additionally, investors in BABA stock actually own shares in what’s called a Variable Interest Entity, and not Alibaba proper. This is nothing more than a contract that provides ownership in a holding company that is contractually entitled to a portion of BABA’s profits. For all you know, this contract could be voided without notice and your investment is gone.
Alibaba stock is way too risky for me.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
