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How Can The Recent Stock Market Troubles In China Impact Alibaba?

Behind the recent downswing in Chinese stocks and the subsequent steps being taken by the Chinese government to arrest the fall, could lie underpinnings of greater economic perils which threaten to slow-down the growth rate of Chinese economy. In a more downside scenario, these challenges could also result in a hard landing for the world’s second largest economy. This is as the recent moves being taken by the Chinese government could cause troubles in its reform process to transition its investment-dependent economy, to one which is more driven by consumption. The recent stock market plunge could likely impact consumption in China in our view, which would thereby impact the earnings of Internet heavyweights such as Alibaba. We believe the worsening of this crisis could warrant downside risks of atleast 20% or more to our valuation for Alibaba
What Is Going Wrong In The Chinese Stock Market?
The Chinese stocks have come under increased focus recently, owing to their recent slide and the subsequent intervention by the Chinese government. After increasing by about 150% during 2014 to June-2015, the Chinese stocks (as represented by Shanghai Stock Exchange Composite Index) have fallen sharply by around 20-30% since mid-June, from their peak levels seen during 2015. Panic selling by retail investors caused this sudden fall in the market; as a result, the Chinese government has taken a slew of measures to curb the fall, including restricting the selling of shares by large shareholders, cutting interest rates, freezing new IPO issues, as well as setting up a fund to buy shares.
While the measures seem to be yielding results in the short-term – the Shanghai Stock Exchange Composite Index rose up by over 5% over the past few days – doubts remain on whether the government will be fully able to arrest the decline in prices. Also, the recent developments have raised questions about the long-term growth prospects of the Chinese economy. A country’s GDP is composed of consumption, investment, government spending and net exports. While consumption is generally the main component for most economies, China’s economy has predominantly been driven by exports and most recently, by investment (post the 2008-2009 global recession). Boosting consumption levels, whose share in the Chinese economy stands at a low of 36-37% as compared to almost 70% for the U.S. economy, is one of the key challenges for the Chinese government in the coming years as it moves towards re-balancing its economy. We think the problem for China is more complex since its real estate market also represents a bubble, fueled by easy access to credit and heightened focus on investment; this makes the recent moves being taken by the Chinese government as counter-productive to its long-term goal of curbing excess credit in the market. Whether or not these problems compound to a hard-landing for China’s economy remains to be seen, but the consensus view is that these problems could cause the growth rates to slow down in China over the coming years.
Possible Slowdown In Consumption Presents 20% Risk To The Stock
Against this backdrop of broader-Chinese economy risks which could also spill-over and affect the whole global economy, we advise a cautious outlook for long-term investors looking to enter the Chinese stock market. Though our price estimate for Alibaba is slightly bullish as compared to the current market price, our valuation estimates do not reflect the downside risks to the Chinese economy. The most immediate impact of this recent downturn could be a slowdown in Chinese consumption, which could have an adverse effect on Alibaba’s earnings as its Chinese retail marketplaces comprise for more than 80% of its revenues. In the event, this crisis worsens or spreads to the debt-ridden property market, it could warrant a significant change in our estimates. A 20% reduction in our Alibaba’s China GMV (gross merchandise value) forecasts till the end of our forecast horizon, would directly lead to an almost 15% decrease in our price estimate. Currently, we have forecast GMV on Alibaba’s Chinese retail marketplaces to rise from RMB 2.3 trillion in 2014 to over RMB 7 trillion by 2021. In effect, the overall impact could be greater than 20% owing to the parallel effect on the advertising and global markets.
Our $99 price estimate for Alibaba’s stock, represents a near-20% premium to the current market price.

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