Should You Buy Alibaba Stock? 3 Pros, 3 Cons (BABA)

Had you bought Alibaba (BABA) stock at the all-time high of $119.95 in November 2014, you would have been in for a disappointment. Shares of Alibaba are trading at $78, so investors would have lost over 30% since then. Needless to say, Alibaba has also lagged the S&P 500 Index, which is up 1.6% since.

alibaba ipo baba stockI wrote about Alibaba on January 27, and advised investors to avoid buying the dip. For short-term traders, I wasn’t too far off the mark, as the stock hadn’t quite bottomed yet. On January 27, BABA stock closed at $69, and two weeks later cratered at $60 a share.

What about longer-term investors? Alibaba is now trading at $78 a share. How are its fundamentals?

 

Alibaba Stock Pros

The E-Commerce Megatrend: E-Commerce is a megatrend, one still in its infancy. Online sales made up just 9% of retail spending in China in March 2015. Jack Ma predicts that this will grow to 50% within 10 years. More and more things are being sold online, and e-commerce is expected to reach $1.1 trillion in China by the year 2020. There’s still a long way to go; China’s internet penetration rate was only 48.8% in June 2015, and Alibaba is looking to expand to rural markets and overseas.

Market Leader: BABA is a leader in all three segments of e-commerce in China. In business-to-business (B2B) e-commerce, Alibaba accounted for 38.9% of sales in 2014, well ahead of its competitors. Alibaba also leads the business-to-consumer (B2C) segment with Tmall. In the first quarter of 2015, Alibaba held 58% of sales in the B2C segment, well ahead of second-place JD.com (JD), which received 22% of sales. Alibaba also leads in consumer-to-consumer sales with Taobao. When combined, Alibaba’s marketplaces represented 81.5% of e-commerce sales in China through 2014.

Insider Buying: Alibaba announced it would be buying back $4 billion worht of BABA stock in August. In February, Jack Ma and Vice Chairman Joseph Tsai participated in a $500 million repurchase using their own personal funds. If the founders are buying, they may very well be thinking Alibaba stock is trading at a discount.

Management generally knows more about the company than the market, as they are privy to information the analysts know nothing about. Given that Alibaba shares have tumbled since the September 2014 IPO, maybe they think Alibaba stock is on the verge of a turnaround.

Alibaba Stock: Cons

Competitive ThreatsAlibaba’s margins are high, but increased competition may erode these. Competitors are already on the move. Tencent Holdings (TCEHY), owner of mobile instant-messaging apps such as WeChat (Weixin) and QQ, has bought into Alibaba’s rival, online retailer JD.com.  The risk for BABA is that busy mobile users may find it more convenient to shop on Tencent’s apps instead of on Alibaba p roperties.

Tencent has shown that it is willing to deploy its edge in mobile against Alibaba; last year Tencent shut down links that allowed Alipay users to send red envelopes to their friends. Instead, they had to use WeChat’s payment service.  

China’s Slowing Economy: Alibaba also faces the risk of slowing sales growth due to China’s slowing economy. China’s economy is slowing; while the government has set a target of 6.5% annual GDP growth until 2020, this might not be possible given that debt is rising 4 times faster than GDP. As I have mentioned before, China’s debt stands at approximately 346% of GDP, and a sudden slowdown in growth could occur, reducing consumer spending. It should be pointed out that this debt increase hasn’t been gradual; the size of China’s banking system has increased 1,000% in 10 years.

Legal and Political IssuesInvesting in BABA stock carries political and legal risks. US investors do not own Alibaba outright, but instead own shares of a Cayman Islands-based holding company which has contracted with Alibaba for a share of the profits. Foreign investors are not allowed to own Chinese internet firms, so there was a need for Alibaba to craft this contract, known as a variable interest entity. In 2011, Alibaba spun off Alipay into a separate entity, against the wishes of shareholders, including Yahoo (YHOO). Foreign investors would likely have little legal recourse should anything happen to their assets. Worse, the VIE structure may in fact be illegal.

The Verdict on BABA Stock

While Alibaba stock does indeed give investors exposure to a fast-growing industry, one should be wary of investing in a country where the legal system is still developing and controlled by the Communist Party. It seems there are a lot of hidden risks that investors cannot be fully aware of, such as accounting standards, Chinese politics, and the shaky legal ground which the VIE is founded on.

So should you buy BABA stock? Warren Buffett advises investors to only invest in things they know about. Unfortunately for investors, we know little about the inner workings of the Chinese government. Given the legal and political risks of investing in China, I would advise long-term investors to steer clear. Perhaps I’m being overly cautious, but we have little knowledge of how much of a risk we are taking in buying Alibaba stock.

As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities. 

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