There is a time-honoured tenet of value investing that says the best deals are to be had by venturing where things are darkest. Right now, that line of thinking suggests bargain-hunters should take a close look at Alibaba Group Holding Ltd .
The Chinese giant, which trades on the New York Stock Exchange under the ticker BABA, controls a sprawling, money-spewing empire that spans everything from online shopping to search engines to electronic payment services. It is Case Study No. 1 in how China’s digital revolution has spawned a legion of world-class consumer companies.
Its problem is that it is also Case Study No. 1 in how to offend China’s prickly leadership. Jack Ma, Alibaba’s co-founder and one of China’s richest people, made a speech in October in which he dismissed China’s state-owned banks and financial regulators as stuffy and behind the times. Immediately afterward, all hell broke loose.
First, Mr. Ma disappeared from public view, for what turned out to be a couple of months. Then, government officials abruptly cancelled the blockbuster debut on public markets of Alibaba’s payments affiliate, Ant Group Co. Ltd., when its initial public offering was only days away from raising a world-record US$37-billion in November. Soon afterward, regulators announced an anti-monopoly investigation into Alibaba.
In April, Beijing slapped the company with a US$2.8-billion penalty for abusing its market dominance. On top of that, Chinese regulators announced a “rectification program” for Ant that will require the payments provider to curtail its headlong expansion into consumer lending and wealth management.
Among the government-ordered remedies, Ant must now apply for licences to become a financial holding company. This implies the company’s financial services division will now be regulated as a bank, with much tighter restrictions and capital requirements than Ant faced as a tech company.
Beijing’s motivation for doing all of this is open to debate.
One line of thinking holds that China’s leadership fears the rising power of its domestic tech elite. If so, the recent crackdown may be intended to send a message to Alibaba and other Chinese technology superstars, such as Tencent Holdings Ltd. and Baidu Inc. , that government still holds the upper hand and dissent won’t be tolerated.
Another view maintains that the crackdown on Alibaba reflects the same concerns about tech monopolies that every advanced nation is now confronting. Viewed this way, Beijing is quite right to be concerned about how Ant can use its dominance in payments processing to gain unrivalled insight into customers’ personal finances and then use that information to expand into areas such as consumer lending, leaving traditional banks out in the cold.
But whatever the rationale, the crackdown by Beijing has cast a long shadow – which is why it may turn out to be an excellent buying opportunity. BABA, the Alibaba share receipts that trade in New York, have slid from a hair under US$310 last October to US$213.72 at Tuesday’s close.
Some of the decline in value is justified by the Chinese government’s new restrictions, especially when it comes to Ant Group, which is 33 per cent owned by Alibaba. Valuing Ant as a highly regulated bank rather than as a tech company will slash its perceived worth to a fraction of the US$320-billion it was valued at last October.
There is still a lot to like about Alibaba, though, starting with the fact that it is growing sales at an astonishing clip for such a large company. Its revenue in the first quarter surged 64-per-cent higher than a year earlier, to US$28.6-billion. The purchase of a supermarket chain, Sun Art, helped drive the increase, but the company says its sales would have grown an impressive 40 per cent year-over-year even without the acquisition.
To be sure, Alibaba broke a long record of profitability by reporting a loss of US$836-million in the quarter. However, the loss was entirely the result of Beijing’s US$2.8-billion fine. The company’s own in-house measure of profitability, which excludes the fine and certain other items, stood at US$4-billion for the quarter, up 18 per cent from a year earlier.
Given its rapid growth and history of profitability, Alibaba’s valuation looks quite reasonable at about 26 times earnings. By comparison, Amazon.com Inc. shares change hands for more than 60 times earnings.
The big question mark? What happens next in Alibaba’s spat with Beijing.
There are grounds for optimism on that score. Beijing chose to fine the company a stinging but not injurious amount, which presumably indicates it does not intend to inflict lasting harm so long as the company co-operates. For his part, Daniel Zhang, Alibaba’s chief executive, has accepted its penalty “with sincerity” and promised to ensure future compliance “with determination.” And Mr. Ma is being seen in public again – although only in controlled situations.
The political risks around the company suggest no one should make Alibaba the core holding in their portfolio. But its attractive valuation and growth prospects suggest it should be on many investors’ radar as a risky but tantalizing speculation.
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