Investors in Alibaba (NYSE:BABA) stock have not had a good year so far in 2021 as BABA stock is down about 33%. Yet, only a year ago, Alibaba was on track to become the first trillion-dollar Chinese tech company. However, the shares have taken a beating in recent months due to tighter regulations by Beijing
Furthermore, BABA stock recently slipped more than 10% in September, as worries about real estate giant Evergrande further spooked Chinese stocks. So far, October is proving to be another volatile month. BABA stock currently hovers around $160, about half its record high of $319 seen last October.
China is the second-largest economy in the world, and Alibaba dominates the country’s domestic e-commerce market with about a 65% share. The group boasts 912 million active customers in China and 1.17 billion globally.
Alibaba’s influence in China extends through various business segments, including retail marketplaces, cloud computing, logistics, wholesale, digital media, and entertainment. The juggernaut also has a significant stake in Ant Group, the payments giant. Ant Group operates Alipay, the financial technology (fintech) name that processes over half of China’s third-party payments.
Let’s take a look at what to expect from BABA stock. If you are a long-term investors with a two- to three-year horizon, you might consider investing around the current level. However, you should also be ready to embrace short-term choppiness in Alibaba shares. Here’s why.
BABA Stock Roiled by China Regulators
Alibaba’s troubles started about a year ago. In late 2020, Beijing’s regulators blocked the planned $34.5 billion initial public offering (IPO) for Ant Group, citing potential risks to China’s financial system.
Under pressure from the Chinese government, Ant Group is being transformed into a financial holding company supervised by China’s state-controlled central bank. Chinese regulators have also proposed breaking up Alipay into three different companies and turning over user data to an entity affiliated with the Chinese state.
Then earlier this year, Chinese regulators launched an antitrust probe into Alibaba’s e-commerce business. Alibaba was fined $2.8 billion for forcing merchants into exclusivity contracts for access to its dominant e-commerce platform.
Chinese regulators have ordered similar large internet platforms to open up their ecosystems to competitors instead of blocking links to them. Alibaba ended up eliminating its exclusive deals with brands and reevaluating its pricing strategies.
The final major blow came in September when Alibaba pledged to spend $15.5 billion in social equity funds to spread China’s prosperity more evenly. These funds aim to help underdeveloped areas and industries, but with an uncertain financial payoff. The timing and size indicate that the move is too generous to be purely voluntary, most likely taken under pressure from the Chinese Communist Party.
Stellar Financials Despite Headwinds
In fiscal 2021, Alibaba’s revenue surged 41% to $109 billion. Adjusted net income that excludes the antitrust fine soared 30% to $26.3 billion. Its core commerce revenue increased 42% year-over-year (YOY), while cloud computing revenue went up by 50%.
In its 2022 Q1 report, Alibaba announced revenue of $31.9 billion, a 34% YOY increase. Adjusted net income increased 10% to $6.73 billion. The company generated $3.2 billion in free cash flow. Alibaba boasts $72 billion in cash and short-term investments on its balance sheet, providing it with the financial power to grow new business segments or acquire emerging rivals.
The current market capitalization (cap) of $398 billion implies that Alibaba has lost about $400 billion in value over the past year. BABA stock trades at 3.4x current sales compared to 3.9x for Amazon (NASDAQ:AMZN). However, Amazon, which is growing at a similar rate as Alibaba, trades at 46x forward earnings, compared to 16x for BABA stock.
In other words, the company could have significant upside potential to offer, including a dominant business that generates plenty of cash. However, Alibaba stock might continue to trade at a lower valuation compared to its peers, as political tensions with China are most likely to escalate in the coming months.
The Bottom Line on BABA Stock
Alibaba’s regulatory headwinds, as well as the market’s distaste for Chinese stocks, continue to depress BABA stock’s valuation. It is a unique business that offers investors growth and solid fundamentals at a depressed valuation, yet remains risky despite its attractive prospects.
Alibaba is in the process of adapting its operations to cope with tighter regulations. Changes could still take some time. Yet the upside could be huge for those investors who can look past the current regulatory issues. Hence, its upside potential makes Alibaba an attractive stock only for those who can stomach considerable political risk. Buy-and-hold investors could consider investing around $155 or below.
On the date of publication, Tezcan Gecgil did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tezcan Gecgil, Ph.D., has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all three levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation.