It has been a wild few years for Alibaba (BABA +6.96%). The pandemic, regulatory crackdowns, and the whereabouts of its co-founder Jack Ma have been the key story lines for the business. More recently, the company announced results for the fiscal 2023 fourth quarter (ended March 31) that missed analyst estimates for sales, but beat on earnings per share.
Investors have a lot to consider before figuring out what to do with this stock, which is down 60% from its October 2020 all-time high (as of this writing). To come to the conclusion of whether or not this business is a buy or a sell, let's look at the bear and bull arguments for this Chinese internet juggernaut.
The bulls make a good point
In the fourth quarter of 2023, 74% of Alibaba's total revenue came from the China and International Commerce groups. For those who aren't familiar, this segment is similar to Amazon's e-commerce operations. According to Statista, Alibaba has a 51% market share of retail online sales in China. That clearly puts it in a wonderful position to continue benefiting from the massive size of the country's middle class.
Strict COVID-19 lockdowns were a huge headwind for Alibaba, as its revenue growth has decelerated. We're still seeing this impact in the most recent quarterly results as well. But the economic reopening in China could be a boon for the company.
Besides the main commerce business line, Alibaba has numerous other operating segments, the most notable of which is the cloud group that also includes Alibaba's artificial intelligence (AI) initiatives. Alibaba is the leader in China in the cloud services industry and the fourth largest in the world (by revenue).
Alibaba plans to spin off this unit into a separate publicly traded company, giving existing shareholders stock in the new entity. With the optimism surrounding cloud businesses, this can unlock meaningful shareholder value.
As I noted earlier, the stock has been beaten down. Because of this, it trades at a price-to-earnings (P/E) ratio of 19.8 today. The lowest level over the past five years was a P/E of 16.2, so the valuation is compelling. Add in the fact that Alibaba generated $25 billion in free cash flow last year, and this could be a good opportunity.
NYSE: BABA
Key Data Points
However, Alibaba bears are also convincing
While spinning off its cloud unit can be a huge value driver, management also announced that it's splitting into six business segments (Cloud Intelligence Group, Taobao and Tmall Group, Local Services Group, Cainiao Smart Logistics, Alibaba International Digital Commerce Group, and Digital Media and Entertainment Group). The rationale for this move is to let each unit operate independently, allowing them to make faster and better decisions.
Moreover, it will free up the lucrative Commerce segment from having to essentially cover the operating losses of all the other segments.
This can unlock shareholder value, but a major restructuring like this adds a tremendous amount of risk. There are so many moving parts to consider. And Alibaba is trying to execute this at a time when markets and economies are under pressure.
Another bear case is the elephant in the room: the regulatory regime. The Chinese government started cracking down on its tech industry more than three years ago because it was becoming too dominant. In April 2021, Alibaba was fined a record $2.8 billion for monopolistic behavior. Numerous other tech giants, including Tencent, JD.com, and ByteDance, have all had to undergo big changes to appease the government.
Some might be wondering if Chinese companies are simply not worthy of an investment right now. After all, the whole point when picking stocks is hoping that the underlying businesses become dominant one day. The fact that the playing field can be completely upended without notice makes it difficult for investors.
Are the risks worth it?
Both the bull and the bear cases for Alibaba's stock are compelling. On one hand, it's hard to deny the attractive valuation for such a dominant business that has secular tailwinds working in its favor. On the other hand, the unpredictability of the regulatory outlook casts a huge shadow of uncertainty over the company.
Investors looking for a safer way to gain exposure to these same sorts of tech markets can look at buying shares of Amazon as an alternative. And for those who simply can't stomach the risk of owning a Chinese stock, it's probably best to stay away for now.
