The city of Hangzhou, where Chinese tech Alibaba (BABA 4.98%) is based, recently announced that it would designate government officials to work with 100 local companies. The city didn't release a full list of those companies, but Chinese state media stated that Alibaba and automaker Geely were both on the list.
The city stated that the initiative was mainly aimed at improving companies' manufacturing capabilities, and Alibaba stated that the representative would only serve as a "bridge to the private sector" and wouldn't "interfere with the company's operations."
Nonetheless, the appointment of a government representative to Alibaba still raises concerns about the tech giant's future. Let's discuss the existing relationship between Alibaba and the Chinese government, and whether or not the latter is tightening its grip on the former.
China's economic strategies
China's "socialist market economy," a term coined in the early 1990s, includes both state-owned enterprises in key industries (like energy, telecommunications, finance, and education) and private sector companies. Those two halves overlap: Investors can buy shares of many state-owned enterprises in China, and the Chinese government tightly controls the behavior of private sector companies with a growing list of regulations.
For example, the government froze the Chinese gaming market by suspending approvals of new games for nine months last year, citing the need for tighter censorship and playtime rules. It also launched a massive investigation into streaming video and social media platforms due to lax censorship, and shut down offending apps.
However, the Chinese government also grants big government projects to companies that play by the rules. In late 2017, the government declared that China's first wave of open AI platforms would rely on Alibaba for smart cities, Tencent (TCEHY 3.86%) for healthcare, and Baidu (BIDU 3.40%) for autonomous cars, which provided all three "BAT" companies with long-term tailwinds.
China considers those top tech companies core growth engines that reduce its dependence on foreign tech and strengthen its position in next-gen markets like AI and automation. It likely believes that competition between the BAT companies will spur the development of better tech, while assigning each of them to specific sectors will modernize the country's infrastructure.
Government services are already deeply integrated into tech platforms like Tencent's WeChat, which lets people pay bills and traffic tickets alongside other services. That lockstep relationship is significantly different from the tense relationships between tech companies, government regulators, and privacy advocates in the U.S.
What does this mean for Alibaba?
In the past, Chinese regulators mainly cracked down on industries like advertising, when misleading medical ads on Baidu resulted in a cancer patient's death; video games, which hurt Tencent's biggest business; and streaming media, which hurt companies like Weibo and Momo.
Alibaba, which generated 87% of its sales from its e-commerce platforms last quarter, isn't heavily exposed to those shifting markets. It generates some revenue from ads, but those are mainly displayed in its own marketplaces; and streaming video via Youku Tudou, but that platform is much smaller than rivals like Baidu's iQiyi and Tencent Video.
Alibaba once ran afoul of regulators in 2015, when China's State Administration for Industry and Commerce (SAIC) accused it of selling counterfeit and low-quality products on its consumer-to-consumer marketplace Taobao. However, Alibaba clamped down on the problem with tougher listing standards, and recently claimed that only one in every 10,000 orders involved problematic products last year.
There's a chance that Hangzhou's government officials might inspect Taobao's operations, but that oversight could force Alibaba to run an even tighter ship to reduce its number of counterfeit products to zero -- which would be good news for investors. Doing so could also convince the U.S. to finally remove Taobao from its infamous piracy blacklist and improve the reputation of its overseas marketplace AliExpress.
Let's not jump to conclusions
Hangzhou might be appointing government officials to inspect certain parts of Alibaba's business or learn about certain technologies (like AI, cloud services, and automation), or it might just be a formality. Therefore, investors shouldn't jump to conclusions.
Instead, they should focus on the facts that matter the most: Alibaba's revenue rose 42% annually last quarter, its adjusted net income soared 54%, and it remains the biggest e-commerce and cloud player in China by a wide margin. Wall Street still expects its revenue and earnings to rise 32% and 23%, respectively, this year.
Those strengths, along with Alibaba's low forward P/E of 20, still make it a top Chinese stock to buy -- despite all the recent noise about the trade war, tariffs, and tighter government oversight.