Short Alibaba After Recent Rally

Alibaba (BABA) managed to achieve a feat that Amazon has struggled to do for years, that is, the company returned money while recording strong top-line and bottom-line growth. Alibaba had been struggling ever since Barrons penned down an article highlighting the company’s flaws. However, shares surged after the solid earnings report. A 12 bps Y/Y increase in Chinese marketplace monetization helped Alibaba beat the estimates on revenue and earnings. As a result, Alibaba’s shares jumped over 10% and are now trading at over $82.

Alibaba’s IPO was one of the most successful one last year as the company’s share surged over 75% in the first two months.

However, the e-commerce giant’s fortunes reversed soon after and the stock fell well below its initial IPO price of $68. Alibaba has staged a stunning recovery as of late as the stock is up almost 30% in the last few weeks. Alibaba’s $2.74 billion buyback and a nice quarterly report have given investors a big vote of confidence in the business. Despite the recent good news, I think Alibaba possess massive downside and investors should use the recent upsurge to initiate a short position in the stock.

Chinese economy still struggling

The Chinese government may have stepped in to stop the stock market crash, but history shows a government intervention just delays the crash and makes it worse. During the crash, IPOs were momentarily halted, shorting stocks was banned and analysts were held accountable for writing anything negative about the Chinese economy. Clearly, the government was desperate to stop the crash.

While the government may have managed to kick the can further down the road, a massive dip in Chinese equities is imminent. Recent numbers show China’s GDP growth slowed down to 6.9%. Although the numbers were above the consensus estimate of 6.8%, the growth fell below 7% for the first time in years. Moreover, I don’t really trust the Chinese government. The government can cook up any numbers they want and chances are a regular Chinese investor will believe it.

Although Chinese equities have staged a stunning recovery as of late, things may get ugly in the next 12-15 months. Overleveraged investors and slowing growth will have a great negative impact on Chinese equities in the coming months.

In addition, the International Monetary Fund (IMF) recently stated that China’s ratio of investment to gross domestic product (GDP) is higher than Japan’s was at the peak of its bubble, which was in 1989. China has clearly entered the bubble territory and while the stock market is now enjoying the “bear rally”, it will not last for long. Thus, I think investors should slowly start initiating a short position in Chinese equities.

Given the recent upsurge in Alibaba’s stock, I think it is a good short candidate. Moreover, as stated by Barrons, history isn’t on Alibaba’s side. Barrons stated:

“Widely hyped Chinese IPOs like Alibaba often flame out like supernovas as growth rates and profit margins suddenly decline. That’s what happened to a business-to-business predecessor to Alibaba Group. On the Hong Kong Stock Exchange in 2007, Ma’s rocketed from its IPO price of 13.50 Hong Kong dollars to nearly HK$40 several months later before beginning an ugly descent to under HK$10 over the succeeding five years. The company was ultimately taken private in 2012 at HK$13.50.”

Considering all the negatives, I reckon investors should initiate a short position in Alibaba and should look at other Chinese stocks to short before the end of 2015.

Published on Nov 4, 2015
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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