Just a few months ago, shares of Chinese e-commerce giant Alibaba (NYSE:BABA) plunged by 22.7 percent over the course of the month. The company had lost approximately 45 percent of its value over a one year period. These losses contrast sharply with Alibaba’s fundamentals, which are generally quite positive. Here’s what you need to know about the disconnect between Alibaba’s price and its fundamentals to determine whether you should buy it as a deep value stock or sell it as fast as possible.
The Bull Case for Alibaba
Fundamentally, Alibaba appears to be a fairly strong company with ample room for future growth. The company announced year-over-year revenue growth of 29 percent in its most recent earnings call. Key growth areas showed even larger increases. Revenue from international commerce increased by 34 percent, while cloud computing grew by 33 percent.
Alibaba’s financial health appears to be in good shape. Its debt-to-equity ratio of 16 percent largely insulates it from potential debt pressures. With rare exceptions, Alibaba maintains positive free cash flows. For the latest quarter, its FCF was $5.52 billion.
Analyst ratings also seem to support a bullish case. The average price target from 50 ratings places the fair market value per share price at $212.34, a sharp increase from its current price. Most analysts also project growth in earnings and revenue extending out into 2023.
Why Did Alibaba Sell Off?
To some extent, the Alibaba selloff resulted from an earnings miss in the most recent quarter. Compared to pre-earnings consensus estimates, Alibaba missed earnings per share by $0.19 and overall revenue by $638.6 million. The company also offered less enthusiastic guidance for next year, projecting revenue growth of 20 to 23 percent in 2022. With that said, the earnings miss does not appear to have rattled analysts, many of whom maintained Buy ratings and still saw substantial upside.
Alibaba’s true problems come from its own domestic market in China. Amid a sharp economic decline and increasing competitive pressure in the Chinese e-commerce market, Alibaba’s growth in China slowed considerably. Revenue from advertising on its e-commerce platform, considered Alibaba’s core business and the only one to have reached profitability as of now, grew by just 3 percent in the last quarter.
Unfortunately, macroeconomic trends in China don’t give many near-term indications of improvement. The combination of an aggressive zero-tolerance COVID-19 strategy, a domestic energy crisis, and harsh regulatory crackdowns have taken a severe toll on China’s economy. Third-quarter growth was just 4.9 percent year-over-year, down from a much more robust 7.9 percent in Q2. Experts expect softer growth going forward, harming companies like Alibaba that depend on China’s historically rapid growth rate.
The aforementioned regulatory crackdown may be the single largest contributor to Alibaba’s difficulties over the past year. The tech sector has been particularly hard hit, with new data security and anti-monopoly laws wiping out billions of dollars in value across the country’s leading tech firms.
The government’s aggressive new stance toward technology companies reached its apex late last year. Jack Ma, co-founder and former executive chairman of Alibaba, disappeared from public view for three months after publicly criticizing banking and regulatory policies in China. Shortly after Ma’s comments, the government blocked the pending IPO of his digital payments company, Ant Group. The incident understandably rattled Alibaba investors and drew a line under China’s growing antipathy toward its tech giants.
Investors fear that Alibaba could even be delisted on US exchanges as regulatory pressures grow. Chinese ride-hailing company Didi recently announced that it would delist from the NYSE and offer its shares in Hong Kong instead. Although shareholders can still trade on an over-the-counter basis, it will be much harder for them to access liquidity. While Alibaba has made no moves toward delisting, the growing political and regulatory challenges it faces could push it that way in the future. With that said, any delisting before 2025 is highly unlikely.
Is Alibaba a Buy or a Sell Right Now?
On fundamentals alone, there’s no denying that Alibaba is severely undervalued. It’s one of the reasons Warren Buffett’s right hand man, Charlie Munger, has been scooping up shares with gusto as the share price fell. The company has demonstrated strong growth, particularly in its international businesses. It also maintains good financial health and appears to have more than enough room to grow going forward. By traditional measures, Alibaba is a Buy. A fair market value analysis places the share price at $192.97 per share.
With that said, the unpredictable direction of regulation in China makes Alibaba much riskier than it appears on paper. The past year has already shown that Chinese regulators are willing to accept losses in the tech sector as a price for pursuing larger political and economic goals. Selling by institutional investors in the current market suggests that these risks could outweigh the considerable value of investing in the company.
Alibaba is a strange case of a stock that presents an incredibly strong case on paper but is strangled by external pressures. Investors comfortable with high levels of risk from potential regulatory and political developments could look to Alibaba as a deep value stock with very high future growth potential. For investors with a medium to low-risk tolerance, however, the company’s future appears both too uncertain and too far outside of its control.