Summary
- Alibaba’s shares cratered on Monday after China’s leader appeared to consolidate power.
- Alibaba shares have been brutalized this year, but investors have become too fearful.
- Alibaba’s effective valuation has dropped to a silly P/E ratio of 7.6 X.
Shares of Alibaba Group Holding Limited ( BABA ) slumped more than 12% yesterday in reaction to a power move by Chinese leader Xi Jinping which instilled more fear in investors about the direction of the world's second-largest economy. With Xi Jinping apparently seeking to consolidate its power, the fear is that China is becoming more authoritarian, which could have negative repercussions for Chinese tech companies like Alibaba. Although Alibaba was not the only Chinese company whose stock cratered on Monday, Alibaba has been in the cross-hairs of regulators before. I believe that fear has taken over investors, making this not a bad time to invest in Chinese tech stocks!
Xi Jinping sell-off
On Sunday, the Chinese Communist Party conducted its 20th National Congress, which was unprecedented in many ways. The Central Committee of the Chinese Communist Part elected Xi Jinping as its general secretary for a third time and it also agreed to fill the seven-member Politburo Standing Committee with Xi Jinping loyalists. The moves are widely seen as attempts to consolidate political power. Additionally, former Chinese leader Hu Jintao was publicly humiliated by being forced to leave the National Congress, seemingly against his will. The election of Xi Jinping as general secretary will have to confirmed in a legislative session in March, but this is likely only going to be a formality.
As a result to these attempts to consolidate power, shares of Chinese tech companies sold off sharply on Monday, including Alibaba, Tencent ( TCEHY ), and Baidu ( BIDU ).
Xi Jinping's power moves strongly indicate that the Chinese economy is going to be ruled in a more authoritarian way going forward, meaning companies like Alibaba will have few options to oppose stricter regulation. Alibaba has attracted the ire of Chinese regulators in FY 2021 for not reporting acquisitions that needed the approval of Chinese authorities. Alibaba was eventually fined $2.8B after a monopoly probe found that the e-Commerce company abused its market position. Chinese authorities were letting Chinese tech leaders know at the time that they were keeping a close eye on their activities.
Alibaba’s business is under pressure, but the valuation reflects this already
COVID-19 lockdowns in 2022 have hurt Alibaba’s business, and many segments have seen a noticeable growth slowdown this year. Alibaba’s China Commerce segment, as an example, saw its revenues decline 1% in the last quarter to $141.9B Chinese Yuan. Key segments such as Logistics (Cainiao) and Local Consumer Services have grown only at single-digit rates in FQ1’23.
Alibaba’s margins also came under pressure in the last quarter… a sign that competition is ramping up in Alibaba’s core segments and that economic headwinds are growing. Alibaba’s consolidated adjusted EBITA margin declined from 20% in FQ1’22 to 17% in FQ1’23, with the largest declines occurring in International Commerce, Digital Media, Logistics and Cloud.
However, I believe the situation could actually improve for Alibaba from here, in large part because COVID-19 lockdowns are no longer as big an issue for the Chinese economy as they were earlier this year and because Alibaba’s valuation is so depressed that the risk profile remains heavily skewed to the upside, despite growing political risks.
Alibaba’s valuation is now officially a joke
As Monday's market reaction has shown, Alibaba’s valuation is now driven more by fear than anything else. While there are legitimate reasons to be concerned about -- such as Alibaba’s top line growth falling to zero in the last quarter or declining margins -- the valuation as such makes no longer any sense. Alibaba is expected to generate $140.0B in revenues and $8.31 in earnings per-share in FY 2023 which implies a P/E valuation ratio of 7.6 X. This means that $1 in Alibaba earnings is currently valued at just $7.60. I don’t believe that this valuation makes sense or reflects Alibaba’s intrinsic value fairly, considering that the e-Commerce company is expected to grow its EPS 17% next year.
Alibaba’s P/E ratio is now also significantly below the 1-year average P/E ratio of 13.8 X.
Risks with Alibaba
Alibaba has many risks, but the upside is also there. Risks include slowing growth in China, the potential of an accelerating government crackdown on large Chinese tech companies after Xi Jinping’s political coup and weakening margins. I believe that the biggest commercial risk for Alibaba is top line growth which slowed to zero percent in the last quarter due to COVID-19 lockdowns in China that hurt consumer spending. What would change my mind about Alibaba is if the Chinese Communist Party forced Alibaba to sell some of its assets -- like Ant Group which owns AliPay, the world's largest mobile payment platform.
Final thoughts
Buy when there is blood in the street. The market is not reacting rationally about Alibaba and other Chinese tech companies right now. China's political leaders may be interested in consolidating power, but they are not interested in hurting the largest and most successful Chinese businesses. Considering that Alibaba’s shares now trade at just 7.6 X earnings (based off of FY 2024 estimates), I believe the market is horribly wrong in its assessment about Alibaba’s fundamental value.
For further details see:
Alibaba: The Market Is Horribly Wrong