Is Alibaba’s major selloff over? I discuss superinvestor buying trends, risks with BABA’s VIE ADR structure and regulatory changes, and some of BABA’s financial updates.
It’s late August 2021, and you may be wondering if we’re out of the woods with Alibaba seemingly hitting rock bottom at around $153 a share, off its high of $317 a share in October 2020, or a -51.7% change. We should consider various factors when evaluating whether a stock is an investment opportunity or not so I hope you enjoy my video!
Main Topics:
Alibaba stock hits low
Superinvestors buying BABA
Explaining ADR and VIE risks
Delisting and regulatory risks
Is the business moat breached?
Alibaba’s $2.8B fine & financial updates
CEO’s Shareholder Letter
Based on a stochastic technical indicator, it seems that BABA was pretty oversold so even though it might be on a new uptrend for now, but that doesn’t necessarily instill any reassurance of where things could go from here.
If anything, to borrow from a Warren Buffett 1987 poker analogy, we should be very aware of what game we’re playing: “As they say in poker, ‘If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.'”
Buffett doesn’t seem to have joined the superinvestor buying spree of BABA over the last couple of quarters in 2021. Charlie Munger, Mohnish Pabrai, Guy Spier, Bill Miller, Thomas Russo, and many more superinvestors have bought BABA as of Q2 2021. Dataroma tracks 72 superinvestors and we’ve seen gradual increases in how many of them are buying BABA.
As much as it feels like Christmas in July and August if you see this as buying opportunity, maybe Charlie Munger has had his fill of BABA as he only had DJCO buy it in Q1 2021, but that didn’t stop Mohnish Pabrai or Guy Spier from buying in Q2 2021. I discuss what their percentage allocations could potentially mean.
You may be wondering, what’s so tricky about Alibaba’s VIE ADR structure? To explain some of the definitions, ADR means American Depository Receipts and it’s what allows foreign equities to be listed on American stock exchanges. And then ADS is American Depository Shares or a USD-denominated stock share of the foreign equities.
Variable Interest Entity (VIE) is basically an offshore shell company that Alibaba has to have in order to list as an ADR in an American exchange so foreign investors would be allowed to buy its stock. But foreign investors are really just buying shares in the shell company as an indirect way of staking claim to Alibaba’s underlying business profits and assets in mainland China.
This is a workaround because the CCP says only Chinese citizens can invest or own Chinese companies. Therefore, to be able to allow foreign investors to participate in equity ownership, it has to go into this VIE structure. Foreign investors may not actually have a true claim to the real Chinese company. The VIE is usually either located in the Cayman Islands or British Virgin Islands as is the case with Alibaba’s contractual offshore companies.
Although rules could change and there’s always a risk in investing in VIE equity, but VIE equity offerings have been around since 2000 with the first one being Sina.com listing on NASDAQ back then. So hopefully VIE will stick around in a manner that maintains investor confidence. As with anything though, we should do our due diligence and check out any and all of the risks that could be related to the VIE corporate structure.
Of course, what’s been hammering the stock prices of many Chinese companies lately has been the concern with regard to changing regulations. This could be coming from both China clamping on offshore listings and the same thing with US regulators. The SEC might want to look at some of what’s going on with the VIE structures. There’s plenty of articles outlining some of the concerns and what foreign investors could be really invested in. Yahoo paints a cautionary tale of its VIE investment in the mid-2000s.
In classic brinkmanship, regulatory rumblings have been escalating over the years that in 2020, Alibaba CFO Maggie Wu assured investors that Alibaba would not get delisted. Some of this is in reaction to Congress passing the Holding Foreign Companies Accountable Act, in which it expects foreign companies to provide to the Public Company Accounting Oversight Board its audits and records from its public accounting firm. In addition, US regulatory officials want to know if there are CCP officials that either own or have a controlling financial interest. If it doesn’t comply and provide the required info within 3 consecutive years, the company could risk being delisted.
While it’s helpful that Alibaba is following the US GAAP rules for its reports so we can try to evaluate the company’s financials, it’s still walking a thin line between competing regulatory expectations from the US and CCP. If I had to guess, there will be some level of compromise.
Over the last year, it’s been easy to be sucked into the negative news about what’s going on with Chinese companies. But we need to distinguish noise from reality and separate the wheat from the chaff. And we could read opinion articles which may have some truth to them, but they could also be exaggerating things. So we should consider if anything has changed in the fundamental core of the business that has maimed its durable competitive advantage, AKA moat, and put it at a disadvantage of its future earnings and cash flows? We all need to form our own conclusions.
For example, we should ask, what does it mean when China has passed one of the world’s strictest data privacy laws? Maybe it’s comparable to the EU’s GDPR rules, but who knows. But we need to seriously consider whether these rules significantly change how these Chinese big tech companies make money. Or if it’s just another thing they need to incorporate into the way they do business and move forward. One meaning of these new rules over user data could be what one AP News article wrote, “future growth will only be possible within the limits of what is good for the Chinese nation.”
The CCP is trying to make its country and economy better for all of its people, and some regulatory changes happening makes the stock market believe some of the affected companies will not be able to recover anymore. But who knows if we’re overreacting and we can’t yet tell what the full extent of regulatory change will hold in the future?
To touch on a few financial points that stood out to me, as many people know earlier in 2021 Alibaba was hit with a $2.8 billion anti-trust/anti-monopoly fine. Alibaba seems to have accepted the penalty with sincerity and wants its industry to comply with normative expectations that Chinese regulators have for Chinese big tech. Maybe there’s a bit of a wild west element going on where Chinese big tech is seeing how much they can get away with before they get reined in by the CCP.
Despite being slapped with the $2.8B fine, Alibaba still generated income of $13.7B in the fiscal year ending March 31, 2021. They seem to be confident about their long term growth prospects because they increased their share buybacks from $10B to $15B (maybe it’s a good time to do so!).
On the not-so-fun-side, they’ve been enjoying lower tax rates of around 17.7% but in FY2022 this may be increasing to between 23%-25%. Perhaps we’ll see less growth in the short term but they seem to be confident about their long term earning potential.
Finally, in addition to evaluating a company’s quantitative performance, we should also look at qualitative factors like CEO Daniel Zhang’s Shareholder Letter and evaluate it for candor, honesty, and transparency. A useful guide to help analyze these letters’ level of candor is Laura Rittenhouse’s “Investing Between The Lines” book. This can help to judge whether a CEO is believable and see if what he’s saying makes sense to us and if we can believe in the future of the company. And if a company like Alibaba can earn shareholders’ “invaluable trust” as CEO Zhang put it in the letter.
If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.
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