Regulatory Issues Aside, Don’t Ignore Alibaba’s Hidden Potential

Alibaba (NYSE:BABA) has had a rough month. The company recently announced that its “loss from operations was 7.66 billion yuan” as a result of its recent fine. Because of negative earnings, BABA stock broke through the important support level of $220. Now BABA stock has lost almost a third of its value from its November highs.

Alibaba (BABA) sign on orange background in office space
Source: zhu difeng / Shutterstock.com

The main cause behind this massive decline is that Chinese regulators have begun exerting regulatory pressure on the country’s large tech firms. Alibaba’s regulatory issues began when the $34.5 billion initial public offering (IPO) of its financial technology affiliate, Ant Group, was suspended. The reason cited was “changes in financial technology regulatory environment.” Chinese regulators also hit the company with an $2.8 billion fine due to anti-competitive practices.

Despite these developments, though, I believe though that Alibaba will eventually straighten out its regulatory issues. At these prices, BABA offers a compelling value.

BABA Stock: Cloud Will Drive Growth for Years to Come

Alibaba is best known for its dominant ecommerce business. However, the company has a slew of other businesses, ranging from entertainment to digital payments. I believe, however, the company’s most promising venture is its cloud services. Similar to how Amazon Web Services (AWS) makes up a significant portion of Amazon’s (NASDAQ:AMZN) value, Alibaba Cloud will become a massive growth driver for BABA stock in the years to come.

For starters, Alibaba Cloud recently became profitable after 11 years of operating history, showing positive adjusted EBITA (earnings before interest, taxes and amortization). This achievement was due to its “realization of economies of scale.” A boost also came from Covid-19 this past year, which saw a lot of firms adopting cloud technology. Additionally, the company noted that digitalization demand remains robust in post-pandemic China, especially in the restaurant and service industries.

That said, Alibaba’s cloud services are still a small contributor to the company’s overall revenue. As of the latest quarter, cloud services only accounted for about 9% of BABA’s total revenue. Worldwide, Alibaba Cloud is also trailing behind leaders Amazon and Microsoft (NASDAQ:MSFT) with a 9.1% market share.

For comparison, Amazon and Microsoft have 45% and 17.9% of the cloud market, respectively. However, this could change in the near future. In the latest quarter, Alibaba’s cloud-computing division grew its revenues by a massive 37% year-over-year (YOY).

China’s Cloud Market Is Booming

Part of the reason I’m so bullish on BABA stock and Alibaba Cloud is because China’s cloud market is on the rise.

China’s cloud industry is still in its infancy. In fact, despite being the world’s second largest cloud-computing market, China’s cloud industry is still a fraction of its U.S. counterpart. However, this means that Alibaba has plenty of room to grow, given China’s much larger population and relative importance to the world economy.

Apart from the aforementioned tailwind of digitalization, the Chinese government has also made cloud computing one of its strategic priorities. Cloud services expenditures grew 62% in Q4 2020, from $2.2 billion in the same period in 2019 up to $5.8 billion recently. This was the “highest ever recorded” growth for the industry according to Canalys, indicating “robust” underlying demand.

Investor Takeaway on BABA Stock

Apart from the promise of Alibaba’s cloud business, though, its traditional ecommerce business has also been performing exceptionally well, despite the fierce competition in China’s market. To be clear, Alibaba’s commerce business brought in well over $25 billion as the continued effects of the novel coronavirus pandemic force shoppers online.

Overall, this company has done superb. Alibaba beat Wall Street revenue estimates handily for the quarter, with a 64% increase YOY. Plus, while the company did report a loss from operations this quarter, the bulk of that is due to the hefty government fine. Without the fine, CEO Daniel Zhang has said that it would have reported a massive 48% YOY increase in operating income. In other words, take away the regulatory issues and Alibaba has had pretty solid results.

This in mind, it is in my view that regulatory issues with tech firms eventually tend to work themselves out. Look at the stock performances of Alphabet (NASDAQ:GOOG) and Facebook (NASDAQ:FB), which have recently faced similar issues.\

BABA stock is currently trading at a trailing 12-month price-earnings (P/E) ratio of 21.37. This is extremely cheap when considering it is still growing at a fairly rapid pace. As such, I believe investors should consider purchasing shares at these prices.

On the date of publication, Joseph Nograles held a long position in MFST, FB and BABA. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.


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