Alibaba’s IPO was met with great enthusiasm last year as it broke the record for the largest US-listed initial public offering. Last September the company raised a total of $25 billion, overtaking the $22 billion IPO of the Agricultural Bank of China – listed in Hong Kong. Fortunes have soured slightly as the Alibaba stock price tumbled 20% over the last two weeks, falling from $104 to $86 a share in response to criticism by the Chinese State Administration and news of disappointing revenues. ali1 (1)

What is Alibaba?

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Alibaba is a Chinese e-commerce company that dominates the Chinese market. It’s like Amazon, PayPal and eBay of China all-in-one package. In 2012 the Chinese giant had $170 billion in sales, which is more than eBay and Amazon combined! Founded and led by a former English teacher named Jack Ma, Alibaba has since become a $200 billion company. It was all going so well. But then, on January 28th, China’s State Administration for Industry and Commerce (SAIC) released a white paper bashing the e-commerce giant over the ubiquity of fake goods on its online retail platforms. The report stated that “Alibaba Group hasn’t been paying enough attention to the mismanagement of the Alibaba Internet transaction platforms for a long time, and hasn’t implemented effective controls to solve the problems”. ali2 The white paper went on to highlight that Alibaba failed to properly regulate what merchants were allowed to sell, that their product information was often inadequate, and that their system for ranking sellers was flawed. Alibaba has been trying to fight the cloud of counterfeit goods for a while now. In December, Alibaba Group announced that it had been successful in taking down more than 90 million fake signings. That’s like the entire population of Vietnam! Then news of disappointing earnings came. The company reported profits of $2.1 billion between October and December 2014, a 25% increase from year-ago levels. The problem was that a very specific metric (GAAP Net Income as seen in chart below) was nearly 30% less than year-ago levels.  Total quarterly revenue, at $4.2 billion, also came slightly under Wall Street estimates of $4.45 billion. The lower than expected earnings combined with anxiety regarding the State Administration’s concerns was enough to send the share price back to September 2014 levels even though profits had nearly doubled from Q3 to Q4 2014. ali4Source: It would seem that fears are overblown. Many analysts see the stock price falling to $75 on fears of rising margins. Others believe that the SAIC’s white paper has highlighted risks investors were unaware of – which is now priced into the stock.

Alibaba will be just fine.

It appears that the company is in prime position to surf the wave of beneficial macroeconomic trends. Online retail sales are about 10% of total retail in China, of which Alibaba represents 80%. The share of online retail sales in overall Chinese retail sales is expected to exceed 15% by 2017 so as more and more Chinese move online. Alibaba stands to profit massively so long as they consolidate their position. Internet penetration in developed countries is around 77%. Even though China has about 632 million internet users, internet penetration in the country is only around 47%. That represents a lot of growth opportunity and as the online landscape in China diversifies that only gives Alibaba more opportunity. Its investments in Lyft, a ride-sharing app, and Tango, a messaging app, indicates their intent to aggressively expand their online empire. The company is also targeting international expansion. They hope to partner with e-commerce players in India and are also targeting countries in Europe, South America and the Middle East. Right now more than 80% of Alibaba’s revenue comes from Chinese retailing but there has been incredible growth in other, smaller areas of the business. The international retail segment of the business has grown revenues by 110% over the last year and cloud computing and internet infrastructure has seen growth of 85% in revenues over the same period. ali5Source: So it seems that this price wobble is just a temporary setback. Wall Street appears to agree; “[o]f the 42 analysts covering the stock, 34 rate it a Buy while only three advocate a Sell.” The consensus price estimate is above $110 and the price dip is generally seen as a good chance to pick up Alibaba at discount.

Here’s why you should NOT buy Alibaba.

The company that is listed on the New York Stock Exchange as BABA does not really represent the actual company. The Chinese government forbids foreigners from investing directly in Internet services in China so Alibaba had to get around this by creating a Variable Interest Entity (VIE) which has contractual rights to the profits of the e-commerce firm. Foreign investors can invest in the VIE, but should you? Unlike a normal investment, investing in the security offered on the NYSE means you are investing in a contract, not the actual company. Alibaba set up a VIE and an offshore holding company, Alibaba Group Holding Ltd, registered in the Cayman Islands. The Chinese VIE pays fees and royalties to the offshore holding company according to a contract between the two. It’s all a bit shady isn’t it? ali6 Furthermore, VIEs are somewhat illegal in China. VIEs are designed to circumvent Chinese law and Chinese courts have previously ruled against foreigners’ claims on Chinese companies via VIEs. The Chinese government has purposely kept their stance vague so as to be flexible enough to backtrack when the concept does not work in the country’s favour. Basically when it comes down to it, your investment has no legal protection in Chinese courts. Generally as a shareholder you are part-owner of a company. As a shareholder of the stock BABA you are part-owner of a contract. Most of the actual assets of the company are still owned by Chairman Jack Ma and another founder, Simon Xie. It’s enough to make you think twice. Or maybe you can just take billionaire entrepreneur Mark Cuban’s view. “They shouldn’t be allowed based on what I know today, but if they’re in, it’s just one more stock to trade or invest in depending on your perspective,”

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