Alibaba: The Great Wall Of Worry Is Crumbling

Summary

  • BABA and other Chinese Internet stocks rallied strongly in a down market on Friday where AMZN sank 14.3%.
  • Bloomberg’s scoop on Friday revealed a better semblance of a favorable conclusion to the delisting drama of Chinese ADRs due to the HFCAA.
  • Beijing’s expression of policy support for the economy on Friday is not new but the high receptivity signals it is getting better at saying what market players want to hear.
  • The E.U. is getting tough on American tech giants, potentially giving their Chinese peers a breather from negative media coverage.
  • With expectations of the Chinese economy lowered drastically, it wouldn’t take much for China to surprise on the upside and bringing Chinese stocks along with it.

Last week, I wrote Alibaba: There’s Always Something To Fear, wondering aloud why allegations regarding accounting “red flags” at Alibaba Group Holding Limited have all but disappeared. Fearmongers could have realized investors are becoming savvier and will not easily fall for such old-fashioned fraud allegations.

Kevin Frayer/Getty Images News

Perhaps, there are so many new ways to spread fear on Chinese stocks that short-sellers don’t have to cook up hundreds of pages of supposed questionable accounting practices or insinuations of fraudulent business activities anymore. There’s the legal ‘gray area’ where the Variable Interest Entity [VIE] structure adopted by Chinese Internet ADRs adopt to attack. Never mind that the China Securities Regulatory Commission [CSRC] reiterated its implicit support for the VIE structure last year.

Bears are also supported by the enactment of the Holding Foreign Companies Accountable Act [HFCAA], and the recent naming of ADRs to the warning list by the SEC. Even for companies like Alibaba Group and JD.com, which have a secondary listing in Hong Kong, delisting concerns continue to build up.

On April 2, the Chinese regulators finally confirmed plans to revise confidentiality rules to give U.S. auditors full access to the U.S.-listed Chinese firms’ audit reports. However, naysayers countered with a “show me” stance, demanding more concrete evidence before they conceded defeat.

Well, Bloomberg’s scoop on Friday revealed a better semblance of a favorable conclusion to the debacle. Citing “people familiar with the matter,” the Bloomberg article is signaling that the Chinese regulators have moved beyond deliberating about the level of access the Public Company Accounting Oversight Board [PCAOB] is allowed to satisfy the U.S. side. Rather, they are “hammering out issues such as quarantine requirements.”

The shift to the nitty-gritty of logistics demonstrates how sincere Beijing is in resolving the hot button issue affecting the existing listings on U.S. exchanges as well as impeding fresh public offerings of Chinese companies. Despite the strict policies the Chinese authorities are placing on both Chinese citizens and foreigners in their attempt to contain the COVID-19 pandemic, they are willing to work out special concessions that may allow PCAOB inspectors to enter China to do their job without the full-fledged quarantine process.

Critics would like to believe this “change of heart” is due to the economic damage following a month of extensive lockdowns in numerous Chinese cities, including China’s largest metropolis of Shanghai, the capital city of Beijing, and the manufacturing powerhouse of Guangzhou. The Associated Press had described the latest COVID wave in China as “extremely grim” as early as April 6, 2022.

More than three weeks have passed and China is still standing strong and is expected to recover quickly. You don’t have to rely on my words or the news. This is what Tim Cook, the CEO of Apple Inc., said about the situation during the Q2 2022 results earnings call on Thursday (emphasis mine):

But looking ahead, we see two causes of supply constraints. One is the COVID-related disruptions; and there’s the industry-wide silicon shortages that will continue. We’ve estimated the constraints to be in the range of $4 billion to $8 billion. And if you – these constraints are primarily centered around the Shanghai corridor. And the – on a positive front, almost all of the affected final assembly factories have now restarted. And so the range – the $4 billion to $8 billion range reflects various ramps of getting back up and running. We’re also encouraged that the COVID case count that’s been reported in Shanghai has decreased over the last few days. And so there’s – there’s some reason for optimism there.

Does this sound like a desperate environment China is in that is causing Beijing to backtrack on its “draconian crackdown” on its tech sector? Believe what you may but Beijing has been working on a resolution since last year. By the way, I also raised in my previous article the perennial bearish argument that China is about to “collapse in the near future.”

Fortunately for the long-suffering shareholders of BABA stock, it doesn’t matter what is the true background when the HFCAA threat is diminished with the demands of the PCAOB satisfied. Furthermore, China, and by extension, the Chinese Internet companies like Alibaba Group, will benefit in the coming months with the easing of lockdowns and the favorable media coverage of the improvements. Potentially positive commentaries from American executives about the amelioration of the situation during the earnings calls, following in the footsteps of Tim Cook, would also help boost sentiment.

Similarly, a statement on policy support for the economy issued on Friday by China’s top policy body, the 25-member Politburo headed by President Xi Jinping, was attributed to the supposed “capitulation” of Chinese President Xi Jinping in the face of economic and social risks and challenges brought about by the extended and widespread lockdowns in key cities as well as the Ukraine crisis.

What is so significant (or rather, different) about Friday’s announcement that led market players to be so excited about Chinese Internet stocks to effect a double-digit percentage jump in BABA, JD, Baidu (BIDU), Pinduoduo (PDD), DiDi Global (DIDI) and scores of other Chinese ADRs during the trading session? BABA stock was up as much as 14% at one point.

The feat is made more impressive considering the broader U.S. stock indices were negative. The Invesco QQQ Trust was closed Friday 4% lower while the KraneShares CSI China Internet ETF closed 8% higher. Amazon.com Inc., the oft-compared company to Alibaba, ended down 14%, after recovering from a steeper loss earlier in the day.

Data by YCharts

Looking back to January, the Chinese government has expressed support for the economy every couple of weeks. For the uninitiated, I hope the following screenshots of news headlines (one each for each month) help.

Today Online
US News/Associated Press
Channelnewsasia
Reuters

Thus, again, it doesn’t matter to BABA shareholders the oddity as long as the share price is up, does it? If I have to hazard a guess, it could be that Beijing is getting better at communicating with market players. This is a clear positive.

I mentioned in the previous article that some investors complained about being “burnt” by their BABA holdings but failed to factor in the relative position of BABA versus their U.S. stocks. With the precipitous fall of the FANG [Meta Platforms (FB), Amazon, Netflix, and Alphabet stocks, considering the high weightage of FANG in a typical American portfolio, the sting from the current downdraft should be several times that of the BABA loss in the past half-year.

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If an investor’s portfolio consisted of a high proportion of high growth, loss-making stocks, the pain would be even greater. This is hardly hypothetical, given the strong prodding by many self-proclaimed investment gurus to switch out BABA stock to SaaS companies, among other high-flying but profitless businesses and momentum stocks. I was similarly enamored by Cathie Wood’s conviction and solid arguments about her selection of growth stocks that I followed her into Teladoc, Coupa, and several others while keeping BABA.

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The contrast may keep intensifying. Protocol, a media outlet that prides itself in “arming decision-makers in tech, business and public policy with the unbiased, fact-based news and analysis”, warned in a recent newsletter that:

While the U.S. might be wringing its hands about how to regulate tech and getting nowhere fast, the EU is through with talking and inclined to take action. The regulation that tech companies have so long avoided is coming. And something about the atmosphere in that room in Brussels tells me it’s not going to stop coming for a very long time.

2021 might have been a year to forget for Chinese Internet platform companies but this year may see them outperforming their American counterparts. As U.S. companies become victims of their successes and are increasingly targeted, the media attention may turn from Beijing to Washington and the E.U., tracking their regulatory moves on these American giants.

The E.U. is done with giving the American tech companies a free pass. Thierry Breton, the Commissioner for the Internal Market at the European Commission, made clear that Elon Musk would have to play by Europe’s rules (when he acquires Twitter): “I don’t care what he’s doing outside of Europe. You want to enter into Europe? These are our rules.”

Finally, I would like to point out that the worry about Beijing’s supposed disregard for foreign investors is also becoming indefensible. The Ministry of Commerce [MOFCOM] announced that mainland China attracted RMB 379.87 billion ($59.66 billion) in foreign direct investment [FDI] in Q1 2022, an increase of 25.6% year-on-year.

Notably, the high-tech manufacturing and services sectors recorded a whopping 52.9% increase y-o-y. If the regulatory crackdowns last year had indeed spooked foreign investors, and that intellectual property theft was as bad as alleged, would the FDI rise that much?

Furthermore, with Chinese President Xi Jinping determined to have the Chinese economic growth outpacing the U.S.’s this year, according to The Wall Street Journal, we should expect investor interest in China to pick up through the year. In any case, with expectations of the Chinese economy lowered drastically following the spate of lockdowns, it wouldn’t take much for China to surprise on the upside.

Bears should watch out for a sudden and sustained recovery in BABA stock. After all, year-to-date, the share price of BABA is back to outperformance over the FANG stocks as of Friday (April 29, 2022). Will this be a harbinger of things to come? Looking forward to hearing your thoughts in the comments section!

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Source: Seeking Alpha

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