Buy BABA Stock? 😢 I Lost $36K

China is on its way to becoming largest economy in the world. Right now, it trails behind the US at second. Based on this fact alone, there are Chinese stocks that have incredible value based on their price and growth... BUT that's arguable.

Chinese companies have faced increased regulatory scrutiny from the Chinese Communist Party (CCP) the past couple of weeks, causing their stocks to tank.

It started with the IPO of Didi (DIDI) – which, in short, is the "Uber of China". Except Didi has 90% market share and more advanced with its autonomous driving business, than Uber is in the U.S. It was supposed to be one of the hottest IPOs of the year, raising more than $4bn at a market cap of over $100bn. However, just two days after its stock market debut in the U.S., Chinese government regulators announced an enforcement against the company for how it has been using— or rather "misusing" — customer data. In essence, the CCP was afraid of their precious domestic data getting in the hands of the U.S. Regulators also had Didi de-listed from the App Store, WeChat and Alipay apps. The stock is now trading nearly 50% lower than its IPO price!

But, the Chinese authorities didn't stop there. They really want to send a message this time. They also confirmed last week that they would ban private education companies from making a profit. In other words, education should be confined to non-profit enterprises – effectively destroying a $100bn industry. This is pretty scary to anyone investing in China. What will they do next?

So, why would anyone invest in China?

Quite simply, as I mentioned, they are on track to being the largest economy in the world. They are home to some extremely valuable companies, like AliBaba, who are priced better than any comparable U.S. stock.

When we look at valuations across geographies, we notice China (and Emerging Markets more broadly) is trading at the lowest multiples; and U.S. equities are trading at the highest differentials. This simply means that there are better opportunities abroad. It's also easy to conclude that U.S. equities are overvalued – something I've been saying consistently. Yes, we are due for a correction. Chinese valuations do seem relatively attractive.

What are BABA stock's fundamentals?

Ignoring the geopolitical risk for a second, let's take a look at Alibaba as a company to evaluate its stock. As always, I start with the breakdown of revenues which you can see below.

The bulk of "Core Commerce" is made up of advertising revenue generated from Taobao and Tmall. Taobao is a C2C marketplace (i.e. eBay), whereas Tmall is a B2C marketplace (i.e. Amazon). So yeah, it's like having both in one company. However, the way in which BABA's China Retail generates revenues, is very different from how Amazon and eBay do. In fact, nearly half of BABA's revenues are derived from advertising, rather than merchant fees or direct commerce. As we know, this is a higher margin business. This only makes me imagine how profitable Amazon can become, and how much potential they have with advertising revenues! The second largest segment of their revenues, do however, come from direct commerce on sites like Tmall Supermarket, Sun
Art, and Freshippo.

Ignore FX adjustments, the Core Commerce segment grew +42% YoY in 2021 (up 8% from the year before). It's very impressive and noteworthy that they were able to maintain an EBITDA margin of 31% with this growth. Overall Adjusted EBITDA margins did decline in 2021 (to 24%), but mostly due to the $2.8bn fine in violation of China's Anti-monopoly law (a record number) – but Alibaba is still a very profitable, fast growth company.

Alibaba's Cloud Computing segment should be profitable very soon; and we know this is a fast-growing, large market, in which they already have a lead.

In terms of Free Cash Flow (FCF), my favorite metric, Alibaba has produced a whopping $26.3bn in FCF last year. That's +32% YoY growth.

Assuming they can grow FCF at 15-20% over the next 5 years, which is a conservative slowdown from their current growth, BABA would have a fair value $265 USD. That's a 42% upside from where it is trading today! It's a steal of a price, considering how low its trading for. Alibaba is growing much faster than Amazon (AMZN), but its valuation is lower in most metrics... by quite the margin. And, as I mentioned, Alibaba is actually a lot more than Amazon; maybe Amazon + eBay + Wish + Netflix + PayPal =BABA. But, for simplicity, let's just compare it to AMZN.

So, it's hard to make the case against the fundamentals of BABA stock. It's extremely undervalued in hypergrowth.

Should why aren't we buying BABA stock?

You probably guessed it... the geopolitical and regulatory risks.

I can't see a reason why the CCP wouldn't want Alibaba to thrive both domestically and internationally; as long as their main objective of control is met. But that's the issue: control.

I personally thought the Biden administration would improve the U.S. relationship with China after Trump started the damage... but, I was wrong. In fact, Biden seems to be continuing the action against China. And, some of it appears to be for valid reasons.

Most recently, the U.S. banned all imports from Xinjiang, China. This was in response to the alleged abuses and forced labor of the Muslim Uyghur minority group. China denies all allegations of human rights abuses, saying its network of detention camps in Xinjiang are for "re-education" of the Uyghurs and other Muslims. I'm not sure what that means. But, Xinjiang cotton accounts for 85% of Chinese cotton production, and 20% of the world’s supply. Here are some brands still linked to forced labor.

Anyways, the most important qualitative factor in buying BABA, or any Chinese stock, right now is the U.S.-China relations. It's my humble opinion that these relations won't improve anytime soon. In fact, I think they'll only get worse. There is no way the U.S. will just roll over and let China overtake it's global power. China's agenda is clear, especially with the digital Yuan. The only thing in China's way is the U.S. dollar.

A major shift if global power may happen in our lifetime, or it may not. But, I do think there's a high chance of this trade & currency war with China escalating to an actual war. The catalyst can be anything, like power over Taiwan. China doesn't seem to be backing down from it, and the U.S. has significant interests in that region. It's a grim picture, but I just don't see this ending well, to be honest.

Ultimately, this means a negative outlook on Alibaba and all Chinese stocks. This is a different risk than most are thinking about; which is CCP regulation. This is one of those cases where I wish I am wrong. But, if you do take Chinese exposure in you portfolio, it'd be wise to limit it to 5% max (imho).

As for my position, I will be holding here until sentiment improves. It doesn't have to be positive, but I'll wait for a better time than now to sell. This could, however, be an opportunity for contrarian investors, with an exit plan.