The Chinese government’s State Administration for Market Regulation (SAMR) wants to stop anti-competitive practices in the internet sector. But whether Alibaba (NYSE:BABA) and Alibaba stock should be worried about those potential changes depends on who you talk to.
Morgan Stanley Thinks It’s An Issue
SAMR issued a press release on November 10 that said it had drafted “Guidelines for Antitrust in the Platform Economy” and would be seeking comment from the public until the end of the month.
SAMR is the Chinese government agency responsible for regulating monopolies. Essentially, the Chinese version of the Federal Trade Commission in the U.S. Alibaba and its peer Chinese internet stocks lost ground on the news, with BABA down more than 8% on November 10.
So yes, the drop in share price is tangible evidence investors are worried about the impact government regulation could have on China’s biggest internet companies.
Morgan Stanley thinks the potential risks are real.
“‘We believe potential implementation of the new antitrust regulations has negative implications for major Internet companies with dominant positions across segments,’” Morgan Stanley analysts wrote in a note to clients.
The investment bank sees these rules as hindering Alibaba’s ability to make acquisitions in the country. It also believes competition will only increase as entry barriers are lowered to incentivize smaller companies to enter the fray.
Between these potential changes to the rules and the delay of Ant Financial’s initial public offering, Alibaba hasn’t had a great November. The biggest worry is that China’s always been Alibaba’s rock.
Investors who backed the company argued that Alibaba’s dominance in China, combined with its expansion into Europe and North America, gave it a very long runway for growth. Heck, I basically said as much myself over the summer:
“As U.S.-listed Chinese stocks go, Alibaba remains the creme de la creme. It’s the gold star of Chinese investments. With or without Covid-19, its future potential remains bright. If I could only own one Chinese company, it would likely be Alibaba. Whether the company gets to $300 by the end of 2020 depends on how the markets perform for the rest of the year. If it does well, I have no doubt it could test $300.”
The point is: If the Chinese government puts a governor on Alibaba’s growth in China, like FTC restrictions on some of the FAANG stocks here in the U.S., it’s going to reduce the valuation that investors are willing to pay, knowing that the gravy train will soon be much lighter.
Further, such regulation would put more pressure on Alibaba to speed up its expansion plans. That’s when mistakes happen. Yes, BABA investors ought to be worried.
Probably Much Ado About Nothing
If the Luckin Coffee (OTCMKTS:LKNCY) fiasco is any indicator, the Chinese government’s desire to clamp down on fraudulent companies or oppressive monopolies appears minimal. Luckin got a slap on the wrist for its fradulent activity — a paltry $9 million fine for fabricating nearly $300 million in sales.
I can’t imagine China would risk killing Alibaba’s golden goose just to appear that it was protecting consumers’ rights. If it really felt that way, Luckin’s insiders would have done jail time. Just ask the two Canadians locked in a Chinese jail because the U.S. got Canada to do Trump’s dirty work regarding Huawei.
But back to the Morgan Stanley analyst note. Although they feel there could be future consequences for Alibaba, the analysts also believe much of the competitive threats have already been unleashed:
“‘Competition has already intensified in recent years, with ‘incumbents’ (e.g., Alibaba, Tencent) losing market share to ‘disruptors’ (e.g. Pinduoduo, Bytedance), so the consequences will likely be less meaningful given reduced dominance across segments compared to a few years ago.”
So, basically, Morgan Stanley is saying it has no clue if the potential damage from any rule changes is real or imagined. I would argue the latter.
The Bottom Line on Alibaba Stock
Alibaba reported excellent second-quarter results on November 5. The number that stood out for me was $6.0 billion in free cash flow, 33% higher than a year ago.
As long as it continues to generate free cash like the Federal Reserve prints money, I don’t think Alibaba shareholders need to worry about the future. In fact, the recent drop in its share price might be the perfect time to buy BABA stock.
Alibaba remains my favorite Chinese stock with or without rule changes in the internet sector.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.