Shares in Alibaba Group Holding (BABA 0.50%) and AMC Entertainment Holdings (AMC -9.73%) are popular among retail investors, ranking among the top 100 widely held on the Robinhood Markets platform. But despite the hype, both companies carry a high level of risk that could leave investors badly burned. Let's explore how aggressive regulation in China and poor fundamentals could put downside pressure on both companies.
I was previously bullish about Alibaba stock because of its dominant position in Chinese e-commerce and compelling valuation (now just 18 times forward earnings). However, the collapse of China's second-biggest property developer, China Evergrande Group, highlights an alarming level of regulatory uncertainty in the country, and Alibaba is already on the chopping block.
In August 2020, China introduced its "three red lines" policy, which restricted leverage ratios for property developers. The new rules helped unravel Evergrande's debt-fueled business model, putting it at risk of a spectacular default. That said, Alibaba is not Evergrande. And I hesitate to claim China is purposely cutting its biggest companies down to size. But that's what seems to be happening, and the crackdown is already chipping away at Alibaba's economic moat.
In September, Beijing expressed plans to break up Ant Group's Alipay platform and create a separate app for its loan business. This change would be a big hit to its business model, which bills itself as a one-stop shop for online payments and traditional financial products. This operating model allows Ant Group to capture efficiencies and synchronize user data.
Alibaba owns 33% of Ant Group, which was once expected to go public at $313 billion in late 2020. Ant's estimated valuation has now fallen to $144 billion, according to Fidelity. And it could drop further if the new regulations take effect. To put these numbers in perspective, Alibaba currently boasts a market cap of $432 billion. And while the company's core operations remain strong (with total revenue growing 34% year over year to $32 billion in the fiscal first quarter), shares are down 38% year to date in response to the intensifying regulatory challenges.
2. AMC Entertainment
In September, AMC Entertainment decided to accept the cryptocurrency Dogecoin for online payments after CEO Adam Aron asked his 174,000 Twitter followers for advice. AMC seems to be embracing the meme community that is keeping its stock inflated. But hype doesn't make up for fundamentals, and the company's financials are still in shambles.
At $445 million, AMC's second-quarter sales are still down 70% against this time in 2019 (before the pandemic). And the company is still bleeding cash -- reporting an operating loss of $297 million in the period. That sum is an improvement from the $472 lost in the prior year period, but nowhere near enough to keep the business running without needing to raise capital through debt or additional shares. With $1.8 billion in liquidity as of the second quarter, this won't be a problem -- for now.
But the picture isn't all gloomy. According to management, AMC expects to achieve a positive theater-level cash flow by the fourth quarter, assuming a domestic box office of at least $5.2 billion this year. Walt Disney's decision to debut the rest of its 2021 films exclusively in theaters could help AMC meet its guidance.
These positive trends could have made AMC stock a viable investment for risk-tolerant investors if it had a reasonable valuation. But with a market cap of $21 billion, the stock trades for an eye-watering premium over its pre-pandemic valuation. At the start of January 2019, AMC had a stock price of just $12 and a market cap of around $1.5 billion. It's hard to see what could make the company 14 times more valuable now than it was before the crisis.
Blowing in the wind
The worst thing about Alibaba and AMC Entertainment is that some of their biggest challenges are out of management's control. Alibaba can't stop the Chinese government's regulation. And AMC depends on movie studios creating cinema-bound content to bring people to its theaters. That said, Alibaba's relatively low valuation could potentially limit its downside risk. AMC, on the other hand, has a lot more room to fall.