Why Alibaba (BABA) Stock Suddenly Looks Toxic

It’s official — the once-lauded Alibaba Group Holding (BABA) has become a major letdown. Already down 33% from its November peak, BABA stock has fallen another 5% Wednesday in the shadow of a somewhat lackluster first fiscal quarter, and in the wake of severely disappointed pool of investors.

Alibaba Stock Tanks, Though for Good ReasonThe irony? Alibaba didn’t actually do poorly last quarter. It simply didn’t do as well as expected (read: “hoped”) in Q1, and with BABA stock still priced as if a sales and earnings would both top estimates, shocked investors saw fit to continue jumping ship.

The $64,000 question: Is Alibaba stock finally a buy after its nine-month, 36% drubbing, or could things still get worse from here?

Alibaba Earnings

In its first fiscal quarter of 2015, China’s e-commerce giant earned 59 cents per share on $3.265 billion in revenue. The good news: Analysts were only calling for a profit of 56 cents per share of Alibaba stock. The bad news: Those same pros were collectively expecting a top line of $3.32 billion.

What the media’s coverage of the Alibaba earnings report largely glossed over, though, is the strong year-over-year growth the company managed to drive. Last quarter, the company’s top line was up 28% from a year earlier. Non-GAAP per-share earnings grew 20%, from 3.05 RMB to 3.68 RMB last quarter.

Just as encouraging is the sheer volume of goods that Alibaba sold in its fiscal Q1 2016.

All told, the online retail venue facilitated $105 billion worth of gross merchandise volume, which was 34% higher than the total sales the company drove in the same quarter a year earlier. Unfortunately, analysts were modeling a 38% improvement in gross merchandise volume.

The proverbial nail in the coffin for BABA stock, however, was most likely shrinking margins.

Operating margins fell from 54% in the comparable year-ago quarter to only 52% this time around. In light of (1) greater scale that should allow for widening margins and (2) deliberate efforts to cut expenses during the quarter (especially the expense of employees — in May, Jack Ma announced an outright hiring freeze), it’s a troubling step in the wrong direction.

The Rest of the Story

Be that is it may, current owners of Alibaba stock are taking at least some solace in the fact that the company is putting a stock buyback into motion. All told, up to $4 billion worth of BABA stock could be repurchased by the organization over the course of the next two years.

On the surface, it seems like a boon for shareholders, and in many regards it is. On the other hand, it’s a $190 billion company, and taking roughly 2% of its shares out of the float isn’t exactly a game-changer.

Indeed, the stock buyback may be little more than a publicity/goodwill measure aimed to distract the market from an even more alarming reality.

The issue goes back to May’s hiring freeze, which was ultimately spurred by burgeoning employee compensation costs following calendar Q4’s results. A closer look at those costs, however, reveals much of the compensation was in the form of stock-based compensation.

Take a look at some of the commentary buried in the Alibaba earnings report:

“General and administrative expenses in the quarter ended June 30, 2015 were RMB2,244 million (US$361 million), or 11% of revenue, compared to RMB944 million, or 6% of revenue in the same quarter of 2014. The increase in general and administrative expenses as a percentage of revenue was primarily due to an increase in share-based compensation expense (as discussed in “Share-based compensation expense” below). Without the effect of share-based compensation expense, general and administrative expenses would have been RMB1,013 million (US$163 million), or 5% of revenue, in the quarter ended June 30, 2015, compared to RMB771 million, or 5% of revenue, in the same quarter of 2014.

Share-based compensation expense included in cost and expense items above in the quarter ended June 30, 2015 was RMB3,995 million (US$644 million), or 20% of revenue, an increase of 272% compared to RMB1,073 million, or 7% of revenue, in the same quarter of 2014. Share-based compensation expense decreased 14% from RMB4,632 million in the quarter ended March 31, 2015, primarily due to the effect of mark-to-market accounting arising from changes in the fair value of share-based awards granted.”

Although it’s not clear exactly how many shares were issued as compensation last quarter, nor is it clear to what extent BABA stock will be used as compensation in the foreseeable future, clearly it has been no small amount up until this point.

This seems unlikely to change in the foreseeable future either, forcing investors to wonder if every share of Alibaba stock the company buys back as part of the repurchase plan is going right out the back door again.

Bottom Line

Like most story stocks contend with sooner or later, the Alibaba hype is beginning to fade and reality is starting to set in — no company can produce red-hot growth forever, and running online stores is expensive. Employees can be particularly expensive, even if you’re paying them with stock.

At some point, Alibaba will have to figure out how to grow without (one way or another) buying all of that growth. Until then, BABA stock will be facing a headwind.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/alibaba-stock-tanks-though-good-reason/.

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