If the political risk of Alibaba isn’t enough for you, maybe the very considerable execution risk will be.
Both sets of issues were starkly illustrated in the past two days as the Chinese e-commerce giant was first accused by a regulator of misdeeds before disappointing investors by failing to hit revenue growth expectations.
Alibaba’s shares fell more than 12% in the two trading sessions since, though they still stand about a third higher than when first offered in September.
Of concern to investors, who are now paying roughly 50 times Alibaba trailing annual earnings for shares, was that the company took a page out of the play book of a more mature company, over-delivering on the bottom line but coming up short, albeit at a 40% growth rate, when it comes to revenue.
Investors love that kind of growth, and the combination of China and e-commerce is mouth-watering, when done successfully. Alibaba has a good claim to being the stock of the future, but the fact is that the future, at least that part conducted in China, is a place with some special risks.
China’s State Administration for Industry and Commerce (SAIC) on Wednesday posted a ‘white paper’ leveling accusations that inadequate controls by Alibaba allowed counterfeiting, illegal business and bribery on its platforms. The paper also said the SAIC had delayed the report so as not to interfere with Alibaba’s IPO, a move which, if true, can hardly be said to be in the best interests of investors.
Alibaba officials stoutly defended themselves, labelling the charges “so unfair” and saying they had not seen the paper in advance or requested its delay and were putting large and increasing resources into controls. The paper disappeared from the SAIC website on Thursday.
We can’t know the truth of the charges or the outcome for Alibaba. What we do know is that private companies are creatures of government in China to a much larger extent than in the US or most anywhere else. Alibaba’s ability to build its huge franchise has been courtesy of official approval, and now at least some parts of officialdom are flexing their muscles. Investors should be concerned that the state-run People’s Daily took SAIC’s part in the matter on Thursday, admonishing companies not to misuse their wealth and prestige.
Hottest stock in the hottest industry
This is not the only recent example of official intervention in China making things difficult for a private company. Late last year, authorities in Shenzhen abruptly, and for obscure reasons, stopped providing routine approvals for property development company Kaisa Group Holdings, making it impossible for it to sell or proceed with new projects. Senior Kaisa executives have since resigned and the group has defaulted on an interest payment on an offshore bond, setting off a scramble among creditors for its assets.
Impossible to say how the two stories fit together, if indeed they do, but China is in the midst of a corruption crackdown with wide-ranging and unpredictable results.
Interestingly, investors appear to have reacted more violently to the revenue shortfall than the government allegations. This implies that investors have been more focused on Alibaba as the great growth stock, a position which until the earnings release it had fully justified. After all we are talking about a sell-off on the back of a 40% gain in revenue.
Indeed the worst day’s trading happened at the same time as the SAIC paper came down from its website, something which might be a victory for Alibaba. Just because Alibaba’s share price isn’t as sensitive to political issues does not mean they are not important. The marginal buyer of Alibaba shares since the IPO is not, perhaps, spending a lot of time analysing Chinese political risk. They are true believers with US mindsets, hedge funds engaging in trend following and mutual fund managers wanting to display the latest, hottest stock among their holdings.
“If I could avoid a single stock, it would be the hottest stock in the hottest industry, the one that gets the most favourable publicity, the one that every investor hears about in the carpool or on the commuter train, and, succumbing to the social pressure, often buys,” famed investor Jack Lynch wrote more than 25 years ago.
Alibaba, at the nexus of the enthusiasm for both China and e-commerce, might not be that stock, but if it is not, it is within spitting distance.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
