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 Few of the investors throwing money at Alibaba hand over fist last
week seemed to notice, but China really is now presenting a new
version of itself to the world. Rather than riding to the rescue
when growth slows, as recent industrial production data, the worst
since 2008, shows it most clearly is doing, China now is taking a
more cautious, passive stance.
"China will not make major policy adjustments due to a change in any
one economic indicator," Finance Minister Lou Jiwei said on Sunday,
adding that the country can’t rely on government spending to speed
infrastructure investment.
However you cut it, this raises questions for investors in Alibaba,
a Chinese e-commerce company which executed the biggest ever initial
public offering totaling $25 billion and saw its shares surge 38
percent in their first day of trading.
Those who do back the Alibaba online marketplace will doubtless make
an argument along the lines that it isn’t happening (China’s still
booming! Well, comparatively.) and it doesn’t matter that it is (Alibaba
can grow independent of China!), but of course financial markets
aren’t simply about truth; they also involve the valuation of
uncertainty.
Investors of a skeptical bent have thus far focused on two areas of
potential vulnerability for outside stakeholders in Alibaba, which
is run by Jack Ma, a charismatic (I use this word in its modern
sense of billionaire) former teacher of English.
The first boils down to corporate governance and the second to
politics.
Ma has been straightforward about where shareholders come in his
estimation, saying they rank third behind customers and employees.
While that might be a good strategy, of more detriment to investors
is a corporate structure which effectively insulates executives from
outside pressure. Combine this with the fact that the IPO was of a
holding company in the Cayman Islands which only has a contract that
entitles it to Alibaba’s profits, a matter about which there is some
uncertainty in Chinese law.
That brings in the political angle, which is that companies in
China, even globally famous ones, operate only at the pleasure of
those in power. Laws can change, as can their enforcement. And while
on the positive side Ma is China’s richest man, and clearly has
enough influence to be where he is today, on the negative side Ma
is, well, China’s richest man.
LEVERAGING GROWTH
To be sure, Alibaba, which acts as a marketplace and therefore
carries little inventory, unlike, say, Amazon.com, is fabulously
capital-efficient and makes tremendous margins.
And while those margins aren’t dependent on growth, the valuation
investors have placed on them, which is in a word enormous, is. Part
of the way you get to a very large valuation is by discounting
future growth, especially in Chinese e-commerce, which Alibaba
dominates.
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Part of that is a secular story: e-commerce is winning market share
in a China without a great retail infrastructure, and China itself
is rebalancing its economy more toward domestic consumption. All of
that still holds true. Note too that part of the reason Alibaba has
thrived, and been allowed to, is that it speeds this needed
transition away from exports and investment and toward consumption.
The problem, and markets may be slow to recognize this, is that part
of the expected growth of Alibaba is from growth in the Chinese
economy itself. While China will surely grow quickly this year by
developed world standards, perhaps 7 percent, that represents a
quite rapid decline both from forecasts and from recent experience.
A look at the industrial production data shows a rapid slowing in
investment-driven sectors, like concrete, steel and property. That
is backed up by data on energy generation and consumption. China’s
growth is slowing rapidly, and to judge by recent remarks from
officials, they don’t intend to do very much about that.
It has to be stressed that both the slowdown and the sanguine
response are a big surprise. My guess is that these twin surprises
did not get much weighting in the minds of those selling and buying
Alibaba’s IPO.
If we are looking at a slower-growing China run by officials less
willing to lever up in order to support that growth, we may well see
Alibaba having to operate in the kind of market and against the kind
of backdrop of which it has no experience.
Alibaba investors may discover that high stock market valuations
based on future growth are very much like any kind of leverage: it
only takes a small change in assumptions about that growth to have a
big impact.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund.)
(Editing by James Dalgleish)
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