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The Worst Mistake Alibaba Investors Can Make Right Now

By Leo Sun - Apr 1, 2021 at 8:44AM

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Don't assume the worst is over yet for this Chinese tech giant.

Alibaba (BABA -1.36%) is often considered a solid long-term investment on China's booming tech sector. It owns the country's largest e-commerce and cloud infrastructure platforms, its ecosystem extends across the advertising, media, internet software, and gaming markets, and it consistently generates double-digit revenue and earnings growth.

Yet Alibaba has lost nearly a fifth of its market value over the past six months as regulators in China and the U.S. have scrutinized its sprawling business. Rising bond yields, which sparked a rotation away from higher-growth tech stocks toward value stocks, exacerbated that sell-off.

Analysts still expect Alibaba's revenue and earnings to rise 39% and 27%, respectively, this year, and its stock trades at just 19 times forward earnings.

Alibaba's campus in Hangzhou, China.

Image source: Alibaba.

Alibaba's stock might look undervalued, but investors should always be skeptical of analysts' estimates, especially when it comes to a company that still faces so many headwinds. Alibaba isn't headed off a cliff, but the worst mistake investors can make right now is to assume the worst is over. Instead, I believe the worst is yet to come as regulators tighten their grip on Alibaba.

A growing list of headaches in China

In early 2020, China's SAMR (State Administration for Market Regulation) started expanding its antitrust laws, which had primarily targeted large foreign companies, to also monitor its domestic companies. In late 2020, the SAMR forced Alibaba's fintech affiliate Ant Group to suspend its IPO, fined Alibaba over unapproved acquisitions, and launched a formal antitrust probe into Alibaba's e-commerce business.

The SAMR will reportedly force Alibaba to halt its exclusive deals with merchants and its usage of promotion prices to attract new customers.

It could also pressure Alibaba to divest some of its media assets to curb its online influence, share all of its user data with a state-backed joint venture, and distance itself from its outspoken co-founder and former CEO Jack Ma, who sparked the suspension of Ant's IPO by publicly criticizing China's state-backed banks.

New provisions from the Chinese Communist Party (CCP), which were introduced last year, will also require domestic companies to hire a certain number of registered CCP members to monitor their business practices. To top it all off, the SAMR could levy a one-time fine against Alibaba, which will likely surpass its record $975 million fine against Qualcomm back in 2015.

All those new rules could throttle the growth of Alibaba's core commerce business, which generates most of its revenue and all of its profits. They could also erode its defenses against its main e-commerce rivals, (JD 1.51%) and Pinduoduo (PDD 10.12%), while weakening its ecosystem barriers against other tech giants like Tencent and Baidu.

A tiny shopping cart in front of a laptop.

Image source: Getty Images.

And even more unresolved issues in America

Alibaba's antitrust challenges in China are dominating the financial news cycle, but it also faces three unpredictable regulatory issues in the United States.

First, a new U.S. law -- which mainly targets U.S.-listed Chinese companies -- will require all foreign companies to comply with tighter auditing rules and prove they aren't controlled by a foreign government. If they don't comply for three straight years, their U.S.-listed stocks could be delisted.

As the CCP and SAMR tighten their grip on Alibaba, it could become impossible to comply with those new demands in the U.S. That's why Alibaba launched a secondary listing in Hong Kong in late 2019, and why American investors should be wary of holding its ADR shares.

Second, Alibaba's Taobao has been repeatedly placed on the U.S. Trade Representative's blacklist of "notorious marketplaces" for its alleged sales of counterfeit goods. Pinduoduo has also been included on that blacklist, while -- which operates a first-party marketplace instead of relying on third-party sellers like its two main rivals -- has not.

Lastly, the Chinese government uses Alibaba's facial recognition, cloud, and AI technologies for various surveillance purposes. That controversial relationship, along with its other aforementioned issues, could make Alibaba a ripe target for U.S. sanctions.

The road ahead

The bulls will claim Alibaba's regulatory headwinds are temporary, and its recent slump represents a rare buying opportunity. The bears will note that the Chinese government is setting a ceiling over Alibaba's long-term growth, and the increasingly blurred lines between the government and Alibaba could make it impossible for U.S. investors to hold the stock as new regulations kick in.

I'm siding with the bears until those headwinds dissipate. The stock might look like a bargain right now, but it's cheap for obvious reasons.

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Stocks Mentioned

Alibaba Group Holding Limited Stock Quote
Alibaba Group Holding Limited
$93.19 (-1.36%) $-1.29, Inc. Stock Quote, Inc.
$53.52 (1.51%) $0.80
Pinduoduo Stock Quote
$46.17 (10.12%) $4.25

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