The perception of Alibaba (NYSE:BABA) can diverge dramatically among educated investors. Some believe that BABA stock is a cornerstone of any portfolio, while others say that Alibaba stock is a sign of a market run amok.
The bulls’ view on BABA stock is rather simple: Alibaba is the unquestioned e-commerce leader in China.T hat’s a market with a population nearing 1.4 billion people. Millions of those citizens are moving into the middle class – and into Alibaba’s sweet spot – every month.
The bears’ view is just as simple, however. China remains a Communist country. Given that fact alone, investors could logically decide not to own any Chinese stocks, let alone one valued at nearly US$400 billion. BABA stock carries many risks, one of which is the fact that BABA shareholders don’t actually own shares of the company.
The argument between the supporters and detractors of BABA stock isn’t going to end any time soon – and certainly not ahead of Alibaba’s fourth-quarter earnings, which are due to be reported next week. Personally, I’ve long leaned towards the skeptical side when it comes to BABA stock. Investors can logically disagree – again, this is a stock whose beauty is somewhat in the eye of the beholder – but those who do should at least understand the risks posed by BABA stock.
The Bulls’ View on Alibaba Stock
Alibaba stock admittedly seems almost obviously attractive. The Chinese e-commerce market already is huge, and it’s going to grow by double-digit percentage levels for years, and potentially decades, to come.
Meanwhile, Alibaba has a dominant share of that market and no real challengers in sight. Second-place JD.com (NASDAQ:JD) is scuffling. Western rivals like Amazon.com (NASDAQ:AMZN) have limited or zero presence in the country. Between Taobao, Tmall, and Alibaba.com, BABA covers both the business-to-business and business-to-consumer channels.
Add to that the company’s myriad other efforts. Its cloud business has real value and enormous growth potential. BABA holds stakes in dozens of other companies, including Ant Financial, Sina (NASDAQ:SINA), logistics provider ZTO Express (NYSE:ZTO), and many other public and private entities.
And yet BABA stock trades at 22 times analysts’ consensus forward earnings estimate and even less when the company’s net cash is subtracted from its share price. BABA is priced as though investors expect the company to grow at a moderate pace, but BABA’s earnings can rise by at least 10% every year for some time to come.
The selloff of Alibaba stock – which is down 17% over the past year – seems more related to short-term worries about U.S.-China relations and other factors than to longer-term risks. BABA stock, from a long-term perspective, is available for a cheap price. Moreover, its opportunity is so obvious that the bear case seems almost laughable.
The Bears’ View on Alibaba Stock
That said, bears can point to just as many reasons to avoid BABA stock simply on principle, and Alibaba stock does pose real, material risks.
The company’s accounting is notoriously opaque. There’s little oversight of the company’s spending, limited transparency, and essentially zero power for shareholders who, again, aren’t actually shareholders. Rather, they own a VIE (variable interest entity) which is entitled to a share of Alibaba’s profits.
Alibaba does own 33% of Ant Financial, but as part of the transaction, BABA terminated a profit-sharing agreement with Ant. That agreement was instituted after Alibaba transferred the unit (then known as Alipay) to a company controlled by then-CEO Jack Ma. It’s still not clear why or exactly how that spin occurred. Yahoo!, now owned by Verizon Communications (NYSE:VZ), owned a substantial stake in Alibaba at the time, but didn’t find out about the transfer until five weeks after it had occurred.
Chinese economic growth certainly seems impressive, if you believe the numbers, which few do. China remains a single-party Communist state. And Ma – the country’s richest man – is a member of the country’s Communist Party.
While Ma has stepped away from running the company, the interconnections between the business and the government raise further questions about how shareholders, who are mostly from Western nations, might be treated going forward. As an attorney familiar with Chinese law told Barron’s, “Why anyone would invest in a vehicle that the Chinese government states is against the law is a mystery to me.”
What It Means for BABA Into Earnings
In the context of the dueling cases, the decline in BABA stock over the past seven months makes some sense. Investors have clearly become more nervous about risk and more nervous about China. Alibaba stock offers plenty of exposure to both.
And so the company’s earnings, due next Wednesday, aren’t likely to change the outlook of Alibaba stock all that much. The company’s Q3 earnings, despite disappointing revenue, did propel BABA stock higher, but the advance reversed in December as trade-war tensions rose. Alibaba’s actual numbers aren’t going to do anything for investors who already believe that the numbers are fixed to some extent or that the corporate structure is untenable. They’re not going to calm investors’ fears that China’s economy is heading for its long-awaited slowdown.
Alibaba stock, rather, is likely to move mostly due to external factors. Progress on the trade talks will help BABA; more bad news on that front will hurt BABA.
A Chinese recession will take BABA down with it. The numbers that are reported on Wednesday may have a short-term impact on BABA, but any impact will be fleeting. Investors who believe in Alibaba may be willing to ride out that volatility. Others, however, may seek out different opportunities.
As of this writing, Vince Martin has no positions in any securities mentioned.