Opportunity or Tragedy? China Crackdown
Identifying opportunities amongst the volatility climate
The Chinese government has tightened controls over various technology companies through regulation and crackdowns. Since the suspension of ANT's IPO, the Chinese government has proceeded with a further clampdown on its technology sector. There are three-part to this crackdown.
- Antitrust crackdown
- Data Security
- Capital expression
Antitrust crackdown
The antitrust enforcement picked up in November 2020 after ANT’s IPO suspension. Alibaba was the first to be hit with the biggest fine, a record of $2.8billion. Many other technology companies such as Tencent(HKG: 0700), Meituan(HKG:3690), Didi(NYSE: DIDI), Baidu(NASDAQ: BIDU), ByteDance, New Oriental(NYSE: EDU), were called in by regulators days after the fine was imposed on Alibaba to rectify antitrust practices.
Data Security
Chinese regulators are concerned about personal data leakage where the US might gain some form of leverage on US-listed Chinese companies. The Cyberspace Administration of China (CAC) was formed in 2014, with a new cybersecurity law passed in 2016. These apply to the Chinese and foreign companies such as Tesla(NASDAQ: TSLA) and Apple(NASDAQ: AAPL). Amidst the crackdown ongoing in China, the US has made it mandatory for Chinese listed companies in the US to declare if there would be any future implications. The Chinese government has launched multiple investigations of tech companies recently regarding data security. One of the notable companies is DiDi, regarding the collection and misuse of personal data. The investigation would take months to plan and, it is very likely more investigations await the other Chinese US-listed companies.
Capital Expression
There are a few objectives that China is trying to accomplish amidst or through this crackdown. China may be trying to reorganize their economic effort to remain competitive on the global stage. Secondly, there might be different agencies in play which resulted in various concurrent events. Lastly, social issues within China such as the workers’ rights and the working culture requires the attention of the government bodies.
What’s happening now?
The education sector within China is also affected as profits from respective education companies are being questioned relating to the ‘for-profit tutoring ban’. In the gaming sector, China has imposed strict measures over the concern of youths’ mental and physical health. Advertising is also affected as companies including Tencent are told to rectify the ‘pop-up windows’ to prevent misleading information.
Additionally…
On Monday, 26th July, talks between the US and China are held to discuss the ongoing tension and find a solution. A few of the key issues addressed are on Xinjiang, Hong Kong, Taiwan and the South and the East China Seas. China has also urged the betterment of the US-China relationship, finding a common ground while reserving differences.
Nasdaq Golden Dragon China Index has fallen 15% (caa 26th July), wiping out approximately $769 billion in value. Investors are exiting the health sector in China, fearing that a crackdown might happen to the medical industry. As concerns regarding further tightening of regulation by China, investors are reducing or removing their position/exposure in China.
What can we do?
As an investor, we have to identify that China and US markets are fundamentally different. These would also mean the risk-return we are exposing ourselves when choosing to invest in the respective economy. The ongoing crackdown reflects the goal in which China prioritizes the public and state interest before the investors and this doesn’t necessarily mean anything in a bad way. Managing our portfolio through diversification and asset allocation would help improve risk management. Lastly, we can invest in companies or industries that align with China or the global vision surrounding sustainable environmental innovations.
Alibaba (NYSE: BABA)
Alibaba’s share price has declined by over 40% since its peak in November 2020, after delaying ANT’s IPO and an antitrust fine of 2.8bn. The share price has declined further as Alibaba donates a third of its cash pile for Chinese initiatives. The share price might not rebound anytime soon given the ongoing crackdown by the Chinese regulators. Alibaba fundamentals have remained unshaken amidst all the negative news, presenting us an opportunity to purchase this company at a discount. During the selldown, I have increased my position in Alibaba and will continue to monitor the ongoing event. My average cost for BABA is $207.36.
Alibaba has 4 main business segments — Core Commerce, Cloud Computing, Digital Media & Entertainment and Innovation Initiatives. 87% of Alibaba revenue is still coming from their Core Commerce segment followed by Cloud Computing and Digital Media. That said, Alibaba has other ventures such as fintech which are growing. Alibaba has seen a 40.72% year over year (YoY) growth in 2021 and a compound annual growth rate (CAGR) of 45.15%. I have also included the estimates for the upcoming years.
Alibaba’s main revenue source still comes from its e-commerce business, accounting for 87% of 2021 revenue. Alibaba gross merchandise volume (GMV) has seen a CAGR of 20.57% over the past 8 years. China’s overall e-commerce revenue is expected to grow at approximately 12% annually.
Alibaba Cloud business has seen a 43.98% CAGR since 2018. As of Q1 2021, Alibaba dominates/takes up approximately 39.8% of the China Cloud infrastructure service market. As the demand for cloud services increases, it is a matter of time for the Alibaba Cloud business segment to grow as well. As seen in research conducted by iResearch, the Cloud service market is expected to grow at 33% annually from 2015 to 2023.
Risk
Alibaba currently faces regulatory risk as the ongoing crackdown would increase uncertainties for investors. The interference in ANT’s IPO and the 2.8bn anti-monopoly fine are some examples of regulatory risk. Such risks are very unpredictable given the involvement of the Chinese government which creates uncertainties and a huge risk for many investors. This uncertainty itself is one of the reasons why the share price has lagged compared to some of its peers.
Peer analysis
Conclusion
Despite the concerns mentioned above, I believe Alibaba is a company with strong fundamentals and an economic moat to deter competitors. They are currently trading at a lower multiple as compared to companies like Sea and Amazon due to concerns about the future of the company. Alibaba has displayed strong returns over the years and I believe it has not yet been reflected in its current share price. They are also operating in various growth industries such as E-commerce, Digital Finance and Cloud Computing. Lastly, I have used DCF for valuation and have derived a conservative estimated share price of $301.30 and a base case share price of $407.48 for 2030. In conclusion, Alibaba has huge upside potential and from a fair value standpoint and is currently trading at a discount.
Disclaimer: This is not financial advice. Please reach out to your respective financial advisors for further queries. Please conduct due diligence before conducting any investments.
