With U.S.-China trade talks entering a dètente, Alibaba (NASDAQ:BABA) shares have rebounded from about $150 in early June to $173 today.
Although the trade talks are far from resolved, with Alibaba focused more on domestic Chinese retail than global e-commerce, the company stands to gain from China’s growing middle class.
But outside of these macro factors, is Alibaba a buy at today’s stock price?
The stock trades at a discount to Amazon (NASDAQ:AMZN), but given its complex ownership structure and related Chinese jurisdictional risks, this discount may be justified. Add in a planned liquidation from a large shareholder, and BABA stock could see downward pressure in the second half of 2019.
Handicapping the U.S.-China Trade War
Alibaba stock could lose big if the U.S.-China trade war comes to blows. At present, the dètente defers — but does not eliminate — this risk.
The company is confident it can withstand the trade war headwinds. For one thing, Alibaba is less dependent on international trade and more tied to the Chinese consumer market. As Sanford C. Bernstein analyst David Dai said, Alibaba has a “hold on Chinese consumers and merchants [that] is almost unassailable.”
Even if the U.S.-China trade war intensifies, Alibaba should weather the storm and continue their growth strategy. In addition, a win-win resolution to the trade war could help bolster Alibaba’s leading catalyst: the growth of China’s middle class.
China’s Growing Middle Class Key to Alibaba’s Future Success
Investors looking at Alibaba stock today should consider the macro story of China’s emerging middle class. Alibaba is best known as a marketplace of Chinese-manufactured goods to the world. But 66% of the company’s FY19 revenue comes from Chinese retail e-commerce.
As Alibaba Vice Chairman Joseph Tsai commented during a conference call in May, Alibaba benefits from increased imports into China. A growing middle class (currently around 400 million) is driving Chinese demand for imported consumer products. As the “Amazon of China,” Alibaba can profit from this demand, continuing their impressive growth into the near future.
Valuation: How Does BABA Compare to AMZN?
On paper, Alibaba appears to be a “cheaper” buy than Amazon. Alibaba currently sells for 49.5 times trailing earnings, and 19.7 times forward earnings. In comparison, Amazon sells for 81.1 times trailing earnings, and 50.8 times forward earnings.
A key factor in the Alibaba stock price discount is the complex nature of the company’s ownership. As InvestorPlace contributor Will Healy discussed in his July 1st article, investors in BABA do not directly own a piece of Alibaba’s business. Instead, they own shares in a Cayman Islands-based holding company entitled to a share of Alibaba’s earnings.
I believe this discount is justified. There is jurisdictional risk when investing in a Chinese-based company.
But this risk premium may indicate an opportunity. If the trade war ends positively, BABA shares should trade closer to AMZN’s valuation.
Altaba Liquidation May Negatively Impact BABA Stock Price
Altaba (NASDAQ:AABA) is a closed-end fund that is the legal successor to Yahoo! Inc. In 2017, Verizon (NYSE:VZ) purchased the operating assets of Yahoo.
Following the divestiture, all that remained was a 16.3% stake in Alibaba, as well as investments in other internet business. Yahoo adopted the Altaba name to reflect the changed nature of the holding company.
Since 2017, Altaba has sold most of their holdings, and now holds less than half of their initial Alibaba stake. In April, plans were announced to liquidate the company.
Altaba shareholders have voted to move forward with the liquidation plan. As a result, through the end of 2019, AABA will sell their remaining BABA position in open-market and private transactions. The sale of this large block of shares could result in downward pressure on the Alibaba stock price.
A counter to this risk is Alibaba’s expected Hong Kong listing later this year. Arbitrageurs with access to both Hong Kong and U.S.-listed Alibaba shares could short the Hong Kong shares and go long the heavily-sold BABA, helping to minimize any spread caused by heavy BABA selling.
Bottom Line: Is BABA a Buy?
Alibaba stock continues to trade at a discount to Amazon. Unlike Amazon, Alibaba has added jurisdictional risk. The U.S.-China trade war may have reached a dètente, but the risk of increased tariffs and restrictions could put downward pressure on the Alibaba stock price.
Alibaba’s future is in selling to the Chinese middle class. By investing in BABA, shareholders can ride this trend and receive a sufficient risk premium (discount of BABA stock relative to AMZN).
Another short-term impact to BABA stock could come from the Altaba liquidation, although arbitrageurs may help mitigate the downward pressure.
For investors taking a look today, Alibaba is a hold. Given that the trade war is far from over, there may be a better opportunity down the road to initiate a position.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
