Alibaba (NYSE:BABA) stock is having an alright year. With shares at about $246 now, the company is up a little over 10% from its January levels. That’s certainly a fine result given the general economic uncertainty.
Still Alibaba’s investors might have expected more. Shares did hit an all-time high of $268 recently but slipped again. And they greatly trail other leading e-commerce plays such as Amazon (NASDAQ:AMZN) and MercadoLibre (NASDAQ:MELI), whose stocks have blasted off following the pandemic outbreak.
What’s holding back Alibaba stock? There are a variety of factors. The impact of the novel coronavirus on the Chinese population was certainly a disruption. Financial market volatility led to a weak earnings report last quarter for Alibaba as well. However, the biggest concern at this point comes from regulators.
Here’s what you need to know about Alibaba stock now.
Understanding Alibaba’s Soft Earnings
In May, Alibaba reported its weakest quarter in a long time. Revenue growth dipped to 22% for the quarter. That actually beat estimates and sounds good given Covid-19 and global economic quagmire. However, it’s still Alibaba’s slowest revenue growth rate in four years.
More shockingly, the company’s headline net income plunged 99%. Interestingly, this was largely due to a decline in investment income. Many investors don’t realize it, however much of Alibaba’s reported profits in recent years come from the value of its investments in other companies appreciating.
This is a bone of contention. Short-sellers allege that Alibaba is using murky accounting to inflate its reported profitability. It’s certainly complicated. And as we saw this past quarter, when markets stop appreciating, Alibaba’s reported net income will slump.
Chinese Stocks to Disappear?
Alibaba’s weak earnings reiterated a key risk around the stock: Much of its apparent success is due to profitable investments, not its core operations. If Chinese tech companies started to drop, then, Alibaba stock would get hit with a double-whammy. Its share price would drop due to the change in sentiment, and it would also report lower earnings thanks to its investment portfolio plunging. Those lower earnings, in turn, would cause sentiment to worsen, triggering a downward spiral.
And now there’s a potential catalyst on the horizon. In May, the Senate passed legislation that would crackdown on Chinese firms listed in the U.S. Companies that didn’t provide adequate financial transparency would be forced to remove their listings from the New York and Nasdaq stock exchanges, and thus lose access to American capital markets.
You may think this is just a few politicians grandstanding. However, some serious investors back the move. Ned Sherwood, a private equity fund manager who lost $20 million on fraudulent Chinese companies recently said:
“I would never put another dime in any Chinese company, and I would never trust a financial statement of a Chinese company in any way as being accurate […] They want to let Chinese companies list here and go public here, but I think they shouldn’t be allowed unless they follow the rules and open their books.”
Lobbyists Fight Back
Of course, there’s a big difference between proposed legislation and actual law. Most Congressional initiatives die on the vine. And it appears this one may may not make it to the finish line either.
The bill’s key backer, U.S. Senator John N. Kennedy (R-LA), admitted as much recently, saying, “Wall Street has unleashed hell lobbying against it in the House, and that makes no sense to me.”
Still, China hawkishness continues, despite the counter-efforts. Just this week, we’ve seen a major diplomatic row break out over the Chinese consulate in Houston. The U.S. forced it to close, claiming that it was a hot spot for corporate espionage in the United States. Pundits suggest that this is more evidence that the U.S. is now actually taking a hard line on China, whereas most of the previous spats were merely verbal.
Verdict on Alibaba Stock
I doubt that the United States truly has the political will to delist Alibaba and other Chinese stocks. While it may play well with voters, the actual reputational harm to the financial system and the country’s capital markets could be considerable. As such, it seems more like a dramatic threat useful for negotiating, rather than an end goal.
And even if Alibaba stock were to get delisted, it’s not like the company’s value would implode overnight. Alibaba’s other listing in Hong Kong gives it sufficient liquidity and international access to maintain a fair valuation. U.S.-based investors would likely be able to transfer their shares to the Hong Kong listing, or sell them at a reasonable price prior to any forced liquidation.
That said, this political question reinforces a broader concern around Alibaba stock The company’s accounting remains complicated, and it’s hard for outsiders to get a good grip on just how profitable the core business is.
The Q1 earnings release, with its dramatic profitability decline due to investments, shows how much of a financial machine Alibaba is.
With the U.S. tightening the screws on the Chinese financial system, this puts Alibaba’s business model at risk. In other words, don’t panic about delisting. But do keep a watchful eye on the U.S.-China diplomatic relations.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.