The past year has been a volatile one for Alibaba (NYSE:BABA), China's largest e-commerce and cloud platform company. The stock price fell with the broader market as the COVID-19 pandemic hit China in early 2020, but rebounded as its online sales rose and stay-at-home measures boosted the usage of its cloud services.

However, a series of regulatory challenges abruptly ended Alibaba's rally at the end of the year. Chinese regulators suspended the long-awaited IPO of Alibaba's fintech affiliate Ant Group, fined Alibaba for its unapproved takeover of InTime Retail, then launched an antitrust probe into its e-commerce business.

Meanwhile, the "disappearance" of Alibaba co-founder Jack Ma, rumors of China's plans to nationalize Alibaba and Ant, delisting threats in the U.S., and the Pentagon's desire to add Alibaba and Tencent (OTC:TCEHY) to an investment blacklist over their alleged ties to the Chinese military all cast a dark cloud over the stock.

Alibaba's campus in Hangzhou, China.

Image source: Alibaba.

However, Jack Ma recently reappeared in public, and the Treasury Department blocked the Pentagon's push against Tencent and Alibaba shortly before President Joe Biden was inaugurated. Alibaba's stock rebounded after those developments, but it's still underperformed many of its peers. Alibaba's stock has risen about 17% over the past 12 months, while Baidu (NASDAQ:BIDU) and Tencent have rallied 87% and 71%, respectively.

Will Alibaba catch up to its "BAT" peers this year? Or will it continue to struggle as regulators kneecap its core businesses and allow rivals like JD.com (NASDAQ:JD) and Pinduoduo (NASDAQ:PDD) to gain ground?

Is Alibaba's business still fundamentally strong?

Alibaba controlled 56% of China's e-commerce market last year, according to eMarketer. JD.com and Pinduoduo held 17.1% and 10.5% of the market, respectively. All three companies operate different business models.

Packages in a warehouse.

Image source: Getty Images.

Alibaba's main marketplaces, Taobao and Tmall, are primarily paid listing platforms. It doesn't take on any inventories, but it fulfills orders through its logistics subsidiary Cainiao. JD.com takes on inventories and fulfills its orders with its first-party logistics network. Pinduoduo offers paid listings like Alibaba, but it encourages shoppers to team up on bulk purchases.

Alibaba generates most of its revenue and all of its profits from its core commerce business, which includes all its online marketplaces, brick-and-mortar stores, and logistics services. It subsidizes the growth of its three other unprofitable businesses -- Alibaba Cloud, its digital media and entertainment unit, and its innovation initiatives -- with the profits from its core commerce business.

This cycle enables Alibaba to expand its ecosystem with other services, including streaming media, cloud services, video games, and even a search engine, to widen its moat against Tencent, Baidu, and other tech giants. It's also enabled Alibaba to generate robust revenue and net income growth over the past five years:

Growth (YOY)

2017

2018

2019

2020

6M 2021**

Revenue

56%

58%

51%

35%

32%

Net Income*

35%

44%

12%

42%

33%

Source: Alibaba quarterly reports. YOY = Year over year. *Non-GAAP. **Percentages are for first six months of fiscal 2021 only.

Analysts expect Alibaba's growth to accelerate in the second half of the year, and for its revenue and earnings to rise 48% and 35%, respectively, for the full year. However, investors shouldn't place too much faith in those forecasts, which might not fully reflect the impact of China's recent antitrust moves against Alibaba's e-commerce business.

Unpredictable headwinds ahead

The growth of Alibaba's online marketplaces was already decelerating prior to the antitrust probe, and the company had grown increasingly dependent on lower-margin businesses -- including brick-and-mortar stores, wholesale channels, cross-border marketplaces, and Cainiao -- to boost its core commerce revenue.

That's why the adjusted EBITA margin of Alibaba's core commerce business dropped to 35% in the second quarter, down from 38% in both the first quarter and the prior-year quarter. That decline might seem minor, but that downward trend could continue and impair Alibaba's ability to support its other unprofitable businesses.

To make matters worse, China's antitrust regulators reportedly plan to prevent Alibaba from locking merchants into exclusive deals. JD, Pinduoduo, and several merchants have called these deals -- which bar Alibaba's sellers from cross-listing their products on other platforms -- anticompetitive. If those new rules are passed, Alibaba's merchants could list their products on other platforms and cause unprecedented challenges for Taobao and Tmall.

The road ahead

Alibaba currently trades at just 20 times forward earnings, compared to forward P/E ratios of 29 and 21 for Tencent and Baidu, respectively.

Alibaba's stock certainly looks cheap, but it arguably faces more regulatory headwinds than Tencent and Baidu. Tencent's recent mergers and fintech businesses are being scrutinized, but its core gaming, social media, and advertising businesses remain fairly secure. Baidu is widely considered an underdog in China's evolving tech market, despite owning the country's largest search engine, so it isn't a major antitrust target either.

I believe Alibaba's valuation will limit its downside potential this year, but I also believe it will underperform Tencent, Baidu, and other Chinese tech stocks as China's antitrust regulators find new ways to rein in its dominant e-commerce and cloud businesses. Therefore, it's still a decent long-term play on China's growing tech sector, but investors shouldn't expect it to generate big market-beating returns this year.