3 Reasons the Selloff of Alibaba Stock Is Temporary

The recent weakness of BABA stock is a buying opportunity

The last three months have understandably been tough for Alibaba (NYSE: BABA) stock. America’s trade war with China has spooked investors. Alibaba is one of the largest and most visible Chinese companies, so the decline of Alibaba stock is entirely logical.

"Counterfeit" lawsuit just noise for BABA stock
Source: Shutterstock

Surprisingly, despite a 17% selloff in the past three months, BABA stock price is still up 9.4% overall year-to-date. That performance is roughly in-line with the overall S&P 500.

There are three primary issues driving BABA stock price lower in recent weeks. All three of them are temporary and have created an excellent, long-term buying opportunity.

Altaba Is Dumping Alibaba Stock

Potentially the biggest bearish catalyst for BABA stock in the past two months has nothing to do with the trade war. In early April, Altaba (NASDAQ: AABA) announced it planned to liquidate its holdings of Alibaba stock. Altaba is the company that remained after Verizon (NYSE: VZ) purchased Yahoo’s internet business back in 2017. The holding company currently has an 11% ownership interest in Alibaba, so one of the largest holders of BABA stock is looking to sell its shares.

Altaba began selling its BABA stock on May 15. As of the end of the first quarter, Altaba held 283.3 million shares of Alibaba stock. Presumably, the market will need to digest at least the vast majority of these shares in coming weeks.

Even the best stock in the world would struggle to rise as tens of millions shares of it were being dumped into the market on a weekly basis. However, as Stifel analyst Scott Devitt noted, Altaba has absolutely nothing to do with Alibaba’s business.

“While the Altaba liquidation creates additional near-term selling pressure, the event has no fundamental bearing on Alibaba and creates an opportunity for long-term holders, in our view,” Devitt wrote.

To take that point one step further, Altaba’s shares have been an albatross for BABA stock for years. Investors knew Altaba would sell its Alibaba stock at some point. Getting the unloading out of the way could ultimately help boost the earnings multiple of Alibaba stock.

BABA’s Margins Trends Are Concerning

One of the biggest bear arguments against BABA stock is that the company’s margins are compressing. Its operating margins dropped from 15% in Q3 to 11.1% in Q4, which was reported last month. Its core e-commerce margins were just fine in Q4,  as the unit’s EBITA margin came in at 35%.

However, Alibaba’s staggering revenue growth comes at a high price.The company has been aggressively investing to grow its merchant base and expand its operations into smaller, more rural cities in China. It has also been investing in high-growth businesses such as cloud services, digital media and other innovative ideas. Last quarter, the EBITA margin of its cloud business was -2%. The EBITA margin of its digital media and entertainment business , by contrast,was about 50%.

Not all BABA’s investments need to produce hits, as long as it produces a couple of home runs over the long-term. In addition, for better or worse, its investment stage will come to an end soon.

“The level of EBITDA margin compression should ease in F2020 versus the ~10ppts of compression in F2019,” Stifel’s Devitt says. Stifel is projecting just a 2% decline in margins in fiscal 2020.

While BABA’s profits and margins are suffering, its investments are paying off huge in the revenue department. Its revenue was up a staggering 51% last quarter. Alibaba is often compared to high-growth U.S. tech stock Amazon (NASDAQ: AMZN). For some perspective on BABA’s growth, Amazon ‘s top line rose just 17% last quarter.

BABA Stock Is Not China

The third and most frustrating reason for the weakness in Alibaba stock is that U.S. investors are using it as a proxy for shorting China. One round of tariff hikes after another is threatening the international business of U.S. and Chinese companies alike.

Chinese companies that sell products to U.S. businesses and customers may be in trouble. Fortunately for the owners of BABA stock, Alibaba is a Chinese company that sells to Chinese customers. In fact, roughly 90% of Alibaba’s e-commerce revenue in 2019 is expected to come from within China.

Yet if the trade war hurts China’s economy, Alibaba’s business could ultimately suffer. However, the company’s 51% revenue growth in Q4 suggests Alibaba is doing just fine so far in 2019.

Despite Alibaba’s relative insulation from the trade war, investors insist on using BABA stock to short China. As of March, S3 Partners analyst Ihor Dusaniwsky said  $20.7 billion worth of Alibaba stock was being sold short, making it the single most shorted stock in the world, in terms of total dollar value.

When the trade war ultimately comes to an end, these selling BABA stock short are going to have to take a hard look at covering their positions. Even after BABA’s heavy investing, Altaba’s dump of Alibaba stock and an unprecedented trade war, BABA stock is up 9.4% this year. At least three of the problems weighing on the stock are temporary in nature. Traders should take advantage of this buying opportunity while they can.

As of this writing, Wayne Duggan was long BABA stock.

Article printed from InvestorPlace Media, https://investorplace.com/2019/06/3-reasons-the-selloff-of-alibaba-stock-is-temporary/.

©2019 InvestorPlace Media, LLC