Chinese e-commerce giant Alibaba Holding Co. (BABA, Financial) has been at the center of the Chinese big tech regulatory crackdown. I have covered this topic extensively in previous articles, and so have many other writers, so I won't bore you with too many details of the past, but amid the regulatory crackdown and the U.S. government introducing legislation to delist the stocks of foreign companies that do not comply with U.S. audit regulations, Alibaba's stock has lost about 72% from its all-time highs in October 2020.
In May, talks of an easing of the tech crackdown and potential progress on coming to an audit agreement between the U.S. and China resulted in a 47% boost in Alibaba's share price. To some, it looked like a recovery was in sight. But then bad news hit on Friday, July 29; Alibaba was added to a list of companies which could be delisted by the SEC in 2024 based on the aformentioned legislation. The stock lost only 7% on the news, but I think this may be an underreaction, as delisting is becoming increasingly likely.
Delisting is becoming more likely
In 2020, the U.S. Securities and Exchanges Commission announced that all Chinese companies with a listing on U.S. exchanges must comply with U.S. accounting standards for their financial reporting. This bold move was mandated by the Holding Foreign Companies Accountable Act passed by Congress that year.
At the time, this caused market fear around Chinese stocks, but ultimately it was assumed by many (including myself) that the U.S. and Chinese regulators would come to an agreement. Surely this legislation was just a bluff to get a few concessions, as actually delisting would be bad for investors in both countries.
However, talks have recently hit an impasse as Beijing has refused to permit U.S. officials to review the work of Chinese auditors, according to Bloomberg. Chinese authorities state security risks from sensitive data as the main issue. Thus, approximately 250 Chinese companies now face a real possibility of delisting from U.S. exchanges, with Alibaba being one of the largest.
Alibaba announced on Monday, July 18 that it is seeking a primary listing on the Hong Kong Stock Exchange, as the company hedges its position. The company currently has a secondary listing in Hong Kong and will aim to convert this to a primary listing.
Chinese regulators recently announced new data laws which prevent any company which captures or stores data in China from transferring it across international borders without the prior approval of the Chinese authorities. Similar laws are already in place in the U.S. and the European Union, though the differences in the scope of this kind of legislation by country is outside the scope of this article.
The Chinese regulators have proposed dividing Chinese firms into three categories based on those that hold non-sensitive, sensitive and secret data. Thus, U.S. auditors could be given access to those with “non-sensitive” data but not to others. Alibaba will likely be in the “sensitive” or “secret” data category as it has data on over 1 billion Chinese users. Thus, the odds of delisting are extremely high.
The upcoming primary listing of Alibaba in Hong Kong is expected to spark a trend of other Chinese companies doing the same.
What does this mean for investors?
If you are an American investor in Alibaba or any other Chinese stock, you are probably experiencing psychological discomfort from this whole situation. The amount of capital retail investors have in Chinese companies is unknown, but U.S. institutional investors have invested around $200 billion in the American depository receipts of Chinese companies.
As a case study, we can look at Chinese ride-share app DiDi (DIDIY, Financial). Didi has recently been delisted from U.S. exchanges, but still trades over the counter via pink sheets. Although this isn’t ideal and liquidity is usually less, it still gives investors access. In addition, the company announced that shareholders will have their shares converted to “freely tradable shares” on another “international exchange,” which I assume to be Hong Kong as the company plans to list there.
Thus, with Alibaba I would expect a similar outcome. It may even be more seamless if the company can execute a primary listing in Hong Kong before the deadline in 2024.
The good news
Despite this crazy volatility, there is a glimmer of hope for Chinese stocks with U.S. listings. Companies which have a primary listing in Hong Kong are eligible to be included into something called “Stock Connect." This is a system which links all the Chinese exchanges (Hong Kong, Shanghai and Shenzhen) together and thus gives mainland Chinese retail and institutional investors access to invest. This could be a real game changer as Goldman Sachs (GS, Financial) forecast this could provide an extra $30 billion of inflows into Chinese stocks listed in Hong Kong.
The Hong Kong stock exchange would see a major boost in daily trading volume from its current $700 million to close to $2.6 billion, which is similar to the New York stock exchange. As a comparison to Alibaba, Chinese tech giant Tencent (HKSE:00700, Financial) is part of Stock Connect; 7% of its stock valued at $29 billion is held by those in mainland China.
Alibaba has a market capitalization of $241 billion, so if it received an equivalent $29 billion in inflows, this would boost the stock by ~12% and may even provide momentum for a larger rally.
Is Alibaba undervalued?
Alibaba's stock is trading at a forward price-earnings ratio of 12, which is 52% lower than its five-year average. In addition, the GF Value chart indicates a fair value of $367 per share, making the stock significantly undervalued at the time of writing.
The stock is held by guru investors Charlie Munger (Trades, Portfolio) and Baillie Gifford (Trades, Portfolio) as of their most recent 13F reports. However, it should be noted Munger halved his position in the first quarter of 2022. Baillie Gifford (Trades, Portfolio) also reduced its position by 70%. Thus, guru investors may see a risk profile which has changed in China.
The company continues to grow revenue at a breakneck pace, though net income suffered from a regulatory fine last year.
Final thoughts
Alibaba is still a dominant e-commerce player in the growing Chinese market, and thus we should remind ourselves there is a business behind every stock. However, there is no doubt the risk profile has changed for American investors in the stock. Unfortunately, sometimes political issues play a key role in investing returns. For the super long term investor (with a five to 10 years timeline), this situation may blow over completely and Alibaba could be a very profitable investment. However, in the short term, expect continued volatility and a high chance of delisting, though the news isn’t as bad as mainstream media would tell you.
