Alibaba Is Poised To Keep Falling Deeper Until Xi Jinping Is Gone

Summary

  • Alibaba’s valuation is indeed cheap amid such strong financial results and an ever-expanding addressable market.
  • But financials and prospects proved to be useless in determining BABA’s stock performance recently.
  • I see no reason to hope for a weakening of the Chinese regime in favor of Alibaba.
  • Everything should change if/when Mr. Xi is replaced by another, more Western-oriented politician – just like Wang Yang.
  • I’d not recommend buying Chinese companies in general, and BABA in particular, no matter how attractive the multiples and growth indicators are.

Thesis

I don’t want you to misunderstand me – Alibaba does have reasons to skyrocket. For example, BABA’s valuation is indeed cheap amid such strong financial results and an ever-expanding addressable market. However, this does not happen and is unlikely to happen until China’s policy softens towards the tech giants like BABA and turns towards the West – I think this will only be possible when Xi Jinping is gone.

Alibaba’s financials, valuation, prospects, and why the stock keeps falling lower?

In the last quarter (1Q 2022), Alibaba managed to increase AAC (Annual Active Consumers) by 45 million people, and now, taking into account non-Chinese customers, the Global AAC equals 1.18 billion – that’s ~15.38% of the world’s population (including all age groups).

Source: 1Q FY2022 IR presentation

Hence, it’s not surprising why revenue is growing so rapidly – there are more and more customers, the business structure is also supplemented by new subsidiaries, which leads to an increase in the average check per customer.

 

Data by YCharts

If we go down in the income statement, we see that the operating profit in the last quarter fell by 11.11%, and EBITA – by 8.02%:

Source: 1Q FY2022 IR presentation

The described decrease is explained by “stepped up investments in key strategic areas” – Community Marketplaces, Taobao Deals, Local Consumer Services, and Lazada. These business segments of the company are growing fast enough, so spending several billion for their development is the right decision. In addition, as you can see, operating losses for most “non-Commerce” segments continued to improve in 1Q 2022, which is also a good sign. For example, “Cloud Computing” has cut operating losses by >¥1 billion – at a pace like this, we may see a positive EBIT as early as next year.

The company’s credit risks are also at fairly low levels: the Debt to Equity ratio continues to fall, and financial debt accounts for only 77% of EBITDA. With the available liquidity on the company’s balance sheet (cash alone is equal to 79.2% of current liabilities), paying off debts will not be a big problem for Alibaba.

Data by YCharts
Data by YCharts

 

One of the key competitive advantages of Alibaba is the presence of its own payment system (Alipay), which belongs to Ant Group. Alipay provides its >1.3 billion users with additional financial services (microcredits, insurance, capital management, etc.) through partner banks, thereby positively affecting their solvency and receiving a share of the banks’ commissions.

It’s also worth noting that the investments made by BABA in the development of international expansion will sooner or later bear fruit, which is going to allow Alibaba to keep on increasing the average revenue check per AAC. The Chinese market is already fully occupied by the company, so the new investments, for example, in Lazada, will also become a key driver of future growth.

Bearing in mind all of the above characteristics and some other factors, analysts predict an average growth rate of BABA’s EPS by ~16.56% over the next 5 years:

Source: Seeking Alpha, BABA, Earnings Estimates

With the current margins and the assumption that Alibaba will grow in the terminal period at a rate of 3% (over 20 years), the fair value of the stock becomes indeed very attractive:

Source: Based on GuruFocus.com

Multiple contraction adds fuel to the fire, correcting as much as the stock itself.

 

Data by YCharts

This is why you see so many bullish articles on BABA here, on Seeking Alpha:

Source: Seeking Alpha, BABA, SA Author’s Rating

If you read the “Bullish” and “Very Bullish” articles, you will find similar rhetoric in favor of BABA’s upcoming recovery – “the stock is undervalued, and the financial indicators are growing rapidly, having room to grow amid a bunch of catalysts.” To this rhetoric is added a discussion of political risks – “regulatory measures against BABA are temporary headwinds and as soon as they end, the stock may double in value.”

However, the bulls, in my opinion, do not understand that the current regulatory measures are not temporary but highly likely permanent headwinds for BABA.

Why the bottom is likely to be even deeper?

Historically, it so happened that a political system built on communist principles inevitably leads towards an authoritarian regime, when the country exists on the principle of “one leader, one nation.” China in this regard is no exception, as evidenced by the chronological picture of what is happening with BABA:

BABA has been facing increased scrutiny by the Chinese government ever since BABA co-founder Jack Ma spoke negatively about the government. Despite Ma’s apology earlier this year, BABA has faced regulatory backlash including the blocking of its planned IPO of Ant Financial and more recently, the proposed breakup of that company. This breakup would include making the Chinese state a part owner in the business. In addition to these developments, BABA has also been required to make a $15.5 billion USD investment to “promote common prosperity” in the country.

Source: Julian Lin’s recent article on BABA

Ma didn’t just “speak negatively about the government” – he compared Chinese regulators to pawnshops, which, due to the presence of a system of “pledges and collateral”, impede the development of the Chinese economy. It should be understood that before that, Ma was “the face of Chinese entrepreneurship for the West”, so from his lips, what he said sounded like a direct accusation to the Chinese Communist Party (CCP), no matter how skillfully Ma tried to quote Xi Jinping from time to time.

As Bates Gill writes, “in a short period of time, Xi has concentrated power to himself and established a remarkably influential role, nearly unprecedented among Chinese leaders since 1949.” I do not doubt that Mr. Xi gave orders for action against Ma and his brainchild. This is also evidenced by the too rapid development of events: a week after comparing the regulator with the pawnshop, Ma was summoned by Chinese authorities for questioning. The next day, Ant Group’s IPO was blocked, despite earlier preliminary approval.

Everything we observe looks like Xi’s revenge, or as an attempt to deprive Ma of the rapidly growing popularity in China – under an authoritarian regime there can be only one true leader, and Ma, due to his popularity and wealth, very often was the #1 figure in the information field. Therefore, other billionaires, who have some power in the country by “right of ownership of wealth”, have also been subjected to exemplary flogging.

Be that as it may, it looks like the regulator’s ultimate goal is to split the BABA business empire. CCP realizes how large-scale resources the company has, one way or another serving literally every person in China. This is all just my assumption, confirmed by actions concerning Ant Group:

Chinese regulators have already ordered Ant to separate from its main business the company’s two lending units — Huabei, which is similar to a traditional credit card, and Jiebei, which makes small unsecured loans — into a new entity and bring in outside shareholders.

Officials now want these lending businesses to have their own independent app as well. The plan would also require Ant to turn over the user data that underpins its lending decisions to a new and separate credit scoring joint-venture that would be partly state-owned, according to two people briefed on the process.

Source: “Beijing to break up Ant’s Alipay and force creation of separate loans app”

On that basis, I don’t think the pressure on BABA and other Chinese tech giants will ease anytime soon. At the very least, it will remain at the same level, otherwise, such serious stock price drawdowns would be quickly bought out.

Anyone who cites the company’s fundamentals when justifying the “high growth potential of its stock” should recall why they generally buy stocks. I’m buying a share of a company to have a claim on its earnings and assets, right? If yes, then how much should I pay for a company that is really growing rapidly, but which I can’t really control (neither its assets nor corporate decisions)? All I get is just a part of its earnings.

VIEs are not technically ownership claims on companies but contractual agreements to part of their profits. This means that BABA shareholders have no vote, and no direct ownership in the company’s assets.

Source: “Alibaba: Keep Your Eye On The VIE”

What happens to my share of the earnings if Alibaba gets a few more fines, similar in size to the last one? How can I, as an owner, influence this? Nohow because I’m not even an owner, but a preferred shareholder who does not receive any dividends (a paradoxical situation).

Conclusion

Based on the common sense and reasoning above, I believe there’s no reason to hope for a weakening of the Chinese regime in favor of Alibaba. Everything should change if/when Mr. Xi is replaced by another, more Western-oriented politician – just like Wang Yang. It is the latter who advocates rapprochement with the West, so his power would have the best impact on the future development of China. Maybe with him, companies will not need to create VIE structures to raise money from Americans and the pressure on techno giants like Alibaba will subside. Until this happens, I’d not recommend buying Chinese companies in general, and BABA in particular, no matter how attractive the multiples and growth indicators are. I’d rather sell my BABA holding if had it in my portfolio than buy out the drawdown every time the stock falls.

Author: Danil Sereda, Seeking Alpha

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