There’s definitely a case to stick with Alibaba Group Holding Ltd (NYSE:BABA) stock long term. BABA stock has been one of 2017’s best performers, gaining 94% year-to-date. Yet Alibaba stock still isn’t that expensive, trading at about 26x 2018 EPS estimates.
The Chinese e-commerce market offers a huge opportunity. A growing cloud business offers a secret weapon for Alibaba stock, as I argued back in February. Alibaba is guiding for 45-49% revenue growth in its fiscal 2018 (ending March), a staggering figure for a company that already has $26 billion in annual sales.
But the run in BABA stock has moderated over the past few months, and with some good reason. There are substantial risks to the stock at the moment that investors must consider. I’ve liked Alibaba stock for most of 2017, and argued the rewards were worth taking those risks. But with BABA stock having nearly doubled this year, I’m no longer convinced that’s the case.
The Concerns Around BABA Stock Are Real
Even as it looks to expand beyond its home country, Alibaba remains a Chinese stock, and that creates its own potential problems. As Lucas Hahn detailed on this site, BABA stock doesn’t actually provide direct ownership of the company. Instead the so-called “variable interest entity” structure provides ownership of a Cayman Islands-based company that has a right to Alibaba’s profits. That in turn means that U.S. shareholders have no technical claim to many of the company’s assets, and no power over them.
In this day and age, that’s not necessarily a deal breaker. Public shareholders in U.S. tech stocks like Facebook Inc (NASDAQ:FB) and Snap Inc (NYSE:SNAP) have limited, if any, voting rights. But the complex structure of BABA stock, and of the entities it controls and acquires, raises significant risk. Well-known short seller Jim Chanos long has questioned the company’s accounting, though he covered his BABA short in January. And Alibaba remains the subject of an SEC investigation on that front.
There’s a broader risk involved, too. At the end of the day, Alibaba still is the largest capitalist business in what remains a controlled, nominally Communist economy. BABA bulls argue that the company simply is too big, and too important, for the central government to restrict its growth. That’s likely true, but it’s not definitely true. While Alibaba is often (and somewhat erroneously) compared to Amazon.com, Inc. (NASDAQ:AMZN), there’s a huge difference between being the e-commerce leader in the U.S. and being the e-commerce leader in China.
Competition Is Coming for Alibaba
Meanwhile, competition is on the way. Second-place JD.Com Inc (ADR) (NASDAQ:JD) steadily is taking market share, as Luce Emerson pointed out in August. JD also has a partnership with Wal-Mart Stores Inc (NYSE:WMT), which should further boost its supply-chain advantage. Amazon reportedly has ceded the Chinese market to Alibaba, but it also will stand in the way of any expansion beyond China.
Alibaba’s cloud business is growing, but the company still substantially trails Amazon, Alphabet Inc (NASDAQ:GOOGL) and Microsoft Corporation (NASDAQ:MSFT). There, too, international expansion may be difficult. Corporate customers, fairly or unfairly, may be loath to store sensitive data with a Chinese company.
To be sure, there’s enough growth in the Chinese economy alone to keep Alibaba’s growth rates up for some time. But if JD.com can keep taking share in China, and Alibaba stumbles at all internationally, the long-term growth profile here may not be quite what bullish investors are hoping for.
BABA Stock Looks About Right
To be sure, most of these risks have existed in one form or another for some time, and Alibaba stock has done just fine. There’s a case that buying the most important business that serves the world’s largest population in the fastest-growing economy is enough in and of itself.
That very well could be true. But there are risks, and BABA stock now is worth about $430 billion. The story here feels a bit too good, at this point. As Josh Enomoto pointed out just a couple of weeks ago, BABA analysts are 100% bullish on the stock, which is itself a potential danger sign. Upcoming earnings are widely expected to be a blowout, as has been the case of late, but higher expectations themselves aren’t always a good thing.
At the moment, everything is going right for Alibaba. The Chinese economy is cooperating, at least according to official figures. It’s a higher-risk tech stock in a market where investors seem highly comfortable with the risk. The Street is on board, and investors are happy. The question after the doubling in Alibaba stock is: What happens when any of that changes?
As of this writing, Vince Martin has no positions in any securities mentioned.
