The Big Risks Of Alibaba Stock (Delisting, Accounting, VIE, Anti-Monopoly)

Well, I said the next video I was going to be talking about the super investors, but you guys were very keen to discuss the risks behind Alibaba stock. So, I thought I'd better make this video first.

In the last video, we did a deep dive on how Alibaba's business works, so definitely check that out if you haven't already. Should be coming up on the screen right now, but in this video we're going to look at all the major risks behind Alibaba stocks. This is definitely a big task, so without further ado, let's get stuck into it.

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Actually, relevant to this video, we had a discussion on the Young Investors Podcast around Alibaba with Investing with Tom. So, if you wanted to listen to that discussion, you can check that out over on the clips channel; link should be coming up on the screen right now. But please head over, subscribe. Now, let's get back to the video.

All right, here we go. Risky, risky business. Alibaba, what's that? You bought Alibaba stock? I also like to live dangerously. Yes, there are definitely some risks, some bigger than others, and we're going to talk about all of the major ones.

In my opinion, the larger risks about to do with Alibaba are, firstly, the China Communist Party getting mad. Then, there's Alibaba's accounting standards maybe not being up to scratch. Then we've got concern about Alibaba getting de-listed in the U.S. And then finally, concern about the structure of Alibaba Group as a variable interest entity.

So, let's start at the start. Risk number one is the Chinese government. Now, I'm not getting political in this video; that's not what I'm trying to achieve. But think about it this way: in investing, we say rule number one is don't lose money. In the China Communist Party, rule number one is don't lose power.

We all know China's government uses their power to directly influence or control their economy. You know if something changes in China, it's because the Chinese government has changed it. Now, obviously, with a company as large and as influential as Alibaba, it's hard to fly under the radar of the Chinese government.

If you're doing something they don't really like, then you better watch out. In fact, we've already seen Alibaba and the Chinese government bump heads. Earlier this year, the Chinese government blocked the IPO of Ant Financial after Jack Ma spoke against China's banking rules.

Then in a separate event, China also handed Alibaba the largest anti-trust fine the country has ever seen. This article reads: "China slapped a record 18 billion yuan or 2.75 billion U.S. dollar fine on Alibaba Group Holding Limited on Saturday after an anti-monopoly probe found the e-commerce giant had abused its dominant market position for several years.

The fine, about four percent of Alibaba's 2019 domestic revenues, comes amid a crackdown on technology conglomerates and indicates China’s anti-trust enforcement on internet platforms has entered a new era—more than double the 975 million paid in China by Qualcomm, the world's biggest supplier of mobile phone chips in 2015 for anti-competitive practices."

So, they slapped Alibaba with the biggest anti-trust fine ever given in China, and because of this, people have been saying, you know, "This is the end of the world; the Chinese government is out to get Alibaba. You know, Alibaba is going to get dismantled by the CCP, broken up and sold off.”

But hold on. Let me read you exactly what Alibaba did, and you can decide whether it's justified that they got a fine. This is from the translated document from China's State Administration for Market Regulation. They said that since 2015, Alibaba Group has abused its dominant position in the market and has imposed "choose one out of two" requirements on merchants on the platform, prohibiting merchants on the platform from opening stores or participating in promotional activities on other competitive platforms. Additionally, they used market forces, platform rules, and data algorithms, and other technical means to adopt a variety of reward and punishment measures to ensure the implementation of the "choose one out of two" requirement to maintain and strengthen its own market power and gain an unfair competitive advantage.

So, they have effectively said to merchants, "If you have a store on a competitor's site, we’ll kick you off of ours." That's pretty anti-competitive. So, you know, maybe a fine was justified in this instance.

But anyway, what people are really concerned about isn't so much the anti-trust fine; it's the idea that China is simply going to start adding new rules that may seriously impact companies in a fairly monopolistic position like Alibaba. And yes, that could potentially happen.

The Chinese government has indicated that they want to crack down on monopolistic practices, and there's no doubt China doesn't hesitate to flex its muscles when it needs to. I mean, just a few weeks ago, we saw China impose new rules that decimated the entire for-profit education industry. That industry just doesn't exist anymore; education companies aren't allowed to make a profit. Bang! Gone. You know, just a few days ago, they enforced a rule that kids can only play online video games for three hours per week. Brutal.

But on the other side of the coin, one thing that I do think should be considered is just how important Alibaba is to the Chinese economy. You know, China is definitely happy that Alibaba exists; it's helped the country a lot. In 2024, Alibaba has a goal to serve more than 1 billion customers through their China consumer businesses and to facilitate more than 10 trillion RMB or 1.55 trillion U.S. dollars of annual consumption on their platforms.

Now, one person's consumption is another seller's income. A 25% corporate tax rate in China on 1.5 trillion is still 375 billion dollars in U.S. dollars in tax revenue just from the goods sold on the platform. Now, China may say, "Well, you know, that's just the price we have to pay to absolutely annihilate Alibaba," and they may impose hefty rules on it.

But you've got to ask, how likely is that? It might not be in the CCP's best interest to take down one of China's most important companies. Have a listen to how Monash For Brigh describes Alibaba and the Chinese regulatory issues.

I mean, do they ever get past those, or do you think that's just part of, you know, doing business? I think Alibaba is a crown jewel for China, just like Tencent is a crown jewel for them. So, I don't think they will want to do things, you know; these are the plays that can have the possibility of global footprints, that they can get there. So, I don't think the government is going to take an approach that is going to, you know, kill the golden goose, if you will. My take is they've extracted their pound of flesh, and they've sent a pretty clear message of who's in charge and such.

So, I don't really expect much more than what we've seen already. As you can tell, Monash definitely follows that thesis more than the idea that China will really crack down and dismantle Alibaba. But again, I don't want to try and sway your opinion one way or another.

For example, China recently reaffirmed that over the next five years they will strengthen laws to prevent monopolies. They said they'd tighten regulations on internet finance, AI, big data, and cloud computing, all of which would impact Alibaba. So, there's definitely some risk. But I mean, there's always risk in investing, right? There's never a no-risk stock market investment.

As always, it's just about managing the risk by finding those scenarios where heads I win but tails, I don't lose much. But anyway, that is the China risk.

Then the next risk we have to talk about is accounting risk. Ah, how can you trust Alibaba's numbers? Chinese companies are all dodgy. I wouldn't touch them with a 10-foot pole. Yep, all right, grandpa. Honestly, this one doesn't really hold up. I mean, Alibaba produces their accounts in line with the U.S. Generally Accepted Accounting Principles and they've had their financials audited by PwC for over 20 years.

PwC is said to be one of the big four accounting firms in the world. It operates in 157 countries and employs 284,000 people based all over the world. So, you know, while it is possible that they are in with Alibaba's management team and they're faking the numbers, I think you have to step back and look at the probabilities on this one.

What are the chances that Alibaba's management team and the whole auditing team of one of the big four international accounting auditors are working together to fake the numbers? I'll leave that one up to you. But you know, to try and give this argument a little bit of credibility, it is worth noting that the PwC Hong Kong member firm has never been inspected by the audit regulator in the United States, the Public Company Accounting Oversight Board.

And that's because the Chinese government forbids the board from performing inspections of the Chinese firms and their U.S. listed company audits. So, again, up to you what you think on that one.

Then this kind of leads us to the third big risk, and in Alibaba's case, that third big risk is a delisting risk. You know, people are buying BABA listed on the New York Stock Exchange and are worried that the stock may get de-listed. Now, to dive into this one we need to understand how Alibaba is structured.

So when you buy into Alibaba from outside of China, you're not actually buying shares in Alibaba's business; you're buying shares in Alibaba Group Holding Limited. This is what's called a variable interest entity, and it's located in the Cayman Islands. This is because the Chinese government doesn't like foreign ownership of their companies.

So what the Chinese companies figured out is they could instead set up these foreign entities that investors can buy into and agree that the foreign entity is entitled to a portion of the profits of Alibaba's businesses. This way, you're still buying into Alibaba, but you're just doing it through a foreign entity that is entitled to what Alibaba can make.

Now, when you look at this VIE, there are actually three forms of Alibaba. There's Alibaba listed on the Hong Kong Stock Exchange, there's Alibaba listed on the New York Stock Exchange, and Alibaba listed on the Frankfurt Stock Exchange.

Now, these are all shares in the Cayman Islands entity just listed on different markets. According to the United States Holding Foreign Companies Accountable Act, in order for the U.S. listed stock to stay listed, they have to prove that they're not controlled by a foreign government, and they have to have their accounts audited by a firm certified by the Public Accounting Oversight Board.

Now this is a potential problem. As I said before, the Chinese government forbids the PCAOB from performing inspections of the Chinese firms and their U.S. listed company audits. So this will need to be figured out across the next three years; otherwise, the U.S.-listed version will be delisted.

Now, if the delisting actually occurred, it's worth noting that you don't lose your shares. So you don't have to stress about losing your shares; it just means these shares will trade over the counter. However, no doubt it would heavily influence the share price, as what you'd find is a lot of funds would be selling their positions as all of a sudden, the rules of their fund would stop them from owning shares of a business that's traded over the counter.

So that is definitely a risk. Now, you can partially sidestep this risk by buying the Hong Kong version of Alibaba. So you would be sidestepping the actual delisting risk, but that wouldn't protect you from the share price declines if a huge wave of institutional selling happened in the U.S. Remember, you're still holding shares of Alibaba Group Holding in the Cayman Islands no matter what exchange you buy it from.

So that is a risk; it's something that needs to be worked through across the next few years to ensure that Alibaba doesn't get de-listed in the States.

And then finally, the final risk of the VIE structure is the Chinese government might actually impose new rules that stop VIEs for Chinese businesses. In my opinion, this risk would mainly be if tensions escalated between China and the U.S., and China just wanted to throw a gut punch their way.

Now, because, as I said before, remember China forbids foreign investment in most Chinese companies. And despite the VIE technically dancing around that legally, the outcome of the VIE goes directly against the Chinese government's intentions. So if the government wanted to crack down on these things, they most certainly could, and that wouldn't be great for us.

However, this is a big if. You know, VIEs have been around for decades and the Chinese government hasn't done anything to stop them so far, so there is an argument there saying, "Well, wouldn't they have already done this if they wanted to?" And that's a fair point, but either way, it's still a risk that you take when you buy Alibaba.

And with that said, they are the major risks with Alibaba's business. I hope you enjoyed the video. Make sure you definitely leave a like on it if you did or if you found it useful; I would certainly very much appreciate it.

Now, in the next video, we're then going to look at why the super investors decided to buy into Alibaba. So definitely stay tuned for that. Again, if you missed my first video explaining every part of Alibaba's business, check that out; it's coming up on the screen right now, or you can check it out; links in the description.

Um, or if you wanted to see a short-form summary and you didn't want to spend the 20 odd minutes, then just go over to the new Money Clips channel. I've made a summary of Alibaba's business over there, so you can check that out as well. And make sure while you're over there, subscribe to the clips channel. Please, please, please.

We're getting that one up off the ground. It's going really well so far. I need to make some more content for the clips channel. Um, but yeah, I'm hoping to get that one up off the ground, so I'd very much appreciate it if you subscribe to that channel.

But guys, that will do us for today. Leave a like on the video if you enjoyed, subscribe if you haven't done so already, and check out Profitful if you would like to. But apart from that, guys, that's it from me. I'll see you guys in the next video.

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