BABAbad Risk Management?

Sometimes whether you buy a stock or not comes down to one big question. Everything I’ve seen on Alibaba really comes down to how much risk you are willing to take on. I’ll focus this piece on where the perceived risk for Alibaba is, along with where I feel the real risk lies.

From a risk perspective, a ton is going on for Alibaba, but I chose to break it into three different categories:

  1. Regulatory Risk
  2. Risk of Competition
  3. Risk of Failure
  4. Cash Cow Risks

Let’s jump in.

Regulatory Risk

I’m a firm believer in that regulation risks are overstated on FAANG+M (Facebook, Amazon, Apple, Netflix, Google and Microsoft). In the US, we suffer from regulatory capture (where those who are supposed to regulate these companies, actually become friendly with the companies).

Yet, China is a whole different monster. Zuck has never disappeared for months after making a relatively straight forward comment. Jack Ma may have been laying low, but this simple example shows the different environments these companies operate in.

In my mind, I see significant risk in the short term (i.e $BABA could drop 20% tomorrow), but not as much risk in the long-term. The best long term predictor of regulatory risk is the past. One example from the past is the cancelled IPO of Ant Financial and increasing regulation going forward. Another instance of possible regulation comes with Didi, where the stock has fallen significantly since IPO, due to threats of regulation from China. I don’t think delisting makes sense, but I do think long term the goal is to have fewer companies IPO in the US. Many of the actions China has taken haven’t been great, but they aren’t terrible.

China is willing to do more regulatory wise than the US, but a better way to view this is through long term incentives. Are Alibaba’s long term incentives aligned with the Chinese governments? Probably not. Can they be without too much pain? I think so. Alibaba will need to adapt.

In many ways, your reaction to the regulatory risk could be greater than the regulations themselves.

Risk of Competition

Holy shit is the competition fierce in China. From JD to Pinduoduo, e-commerce is a warzone. While Alibaba is still the major player, they have been getting beat in newer markets, which is a concerning trend. The competition only gets tougher when you start to zoom out to everything around China (Coupang, Shopee, etc..).

Yet, competition is for losers. If Alibaba is truly still a great company, the only real company they are competing against is themselves. The potential in all their markets are HUGE. China still has a ton of growth ahead of it. No one will dominate it all and Alibaba is years ahead (in some aspects). This is not a winner takes all market, the TAM is too large.

Risk of Failure

To me, a better question than how competitive the industries are is how competitive Alibaba is. At the end of the day, no one will beat Alibaba other than themselves.

I think a huge part of Alibaba comes down to the vision for the future. They are still aggressively building for the future. They have a huge opportunity, but where future growth comes from isn’t super clear. To me, this is the biggest risk in looking at Alibaba. With no next growth engine in sight, Alibaba might be a value company. But if the biggest risk is that Alibaba is a value stock, then that seems to be already priced in.

Valuation Risk

I own a lot of stocks with extremely high valuations (i.e $SHOP) and because of that they need perfect execution. Alibaba has a ton of risk and competition already priced into their market cap. Of all the risks, I don’t consider their valuation to be one.

By valuation risk, I generally mean multiple contraction. At a forward PE of 17, Alibaba is already dirt cheap (possibly for a reason). I’d consider the floor for Alibaba a PE of 12, unless growth turns negative or regulation threats scare the market. If anything, I see upside potential in the valuation of Alibaba, not downside.

Cash Cow Risks

Alibaba is an amazing company, in many ways because they have been extremely forward looking. But the majority of their profits come from their core commerce section. If something did happen to this business, reinvestment becomes more difficult. They use these profits to invest in other industries (like cloud).

Yet, the risk of the core commerce section of Alibaba blowing up doesn’t really seem like a risk at all. The size, scale and diversification of this segment won’t lead to any sizeable struggles soon. I don’t see this being a huge concern. Of far more concern is where future growth comes from.

Wrapping It Up

This is just a quick overview of risk. Alibaba has plenty of other (lesser) forms of risk such as litigation, fraud, etc… It’s important to think of how these risks compare to your current portfolio (upside and downside). Personally, I have very limited exposure to Chinese regulation and a decent amount of overall regulation risk. I’m confident from a risk standpoint that I can own Alibaba. Your reaction to the markets reaction to perceived regulation is the biggest risk. But eventually, the market becomes a weighing machine instead of voting. Cash flow will win out in the end. If you own Alibaba, you need to make sure you have the ability to stomach a downturn. FUD is inevitable, you better be able to avoid it.

Author: fatbabyfunds