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There’s a Problem With Alibaba Stock That Deserves More Attention

Will Healy

Alibaba (NYSE:BABA) has become a contradiction. Given its valuation, one might think of it as a lower-cost alternative to those who bought Amazon (NASDAQ:AMZN) too late. However, the fact that BABA stock is not actually ownership in Alibaba bothers more risk-averse investors. Moreover, ties to China’s Communist party along with murky accounting create other concerns.

There's a Problem With Alibaba Stock That Deserves More Attention

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However, Alibaba is also in the midst of a leadership change. Such transitions can become fraught with problems. In fact, BABA stock investors may have focused so heavily on the current risks that they may be ignoring a problem that makes any accounting or political issues irrelevant.

Alibaba Stock is a Contradiction

BABA stock frustrates some investors. On the one hand, it looks like a bargain compared to its U.S. peer Amazon. Trading at a forward price-to-earnings (PE) ratio below 25, it compares well to Amazon’s 40.6 (and falling) forward PE. Analysts also forecast 14.3% profit growth in 2019 and 23.2% in 2020.

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Conversely, BABA stock also holds risks not shared by AMZN. In previous articles, along with my InvestorPlace colleagues, I have mentioned the fact that owning BABA is not owning Alibaba. Instead, investors own a Cayman Islands-based holding company which receives a share of Alibaba’s profits. Also, accounting practices also call the true financial condition of Alibaba stock into question.

Beware the Conglomerate Status

However, the problem for BABA stock that receives less attention is Alibaba’s conglomerate status. Yes, one can say the same about Jeff Bezos at Amazon. However, Bezos remains firmly entrenched in his CEO position. This is not the case with BABA. Now that Jack Ma has started to transition out of the company, the pressure will fall on new CEO Daniel Zhang. History shows that these types of firms fare poorly when handed to a successor.

The problem with conglomerates is they tend to become an entity that only the current CEO can manage. They then proceed to fall apart once they move to a successor. We saw this on the geopolitical stage when Yugoslavia’s disparate culture groups tore the country apart in the 1990s after the death of Marshal Tito. This also occurred in American business with GE (NYSE:GE) following Jack Welch’s retirement. Since Welch left, GE has continued to shed many of its businesses as they became unmanageable. It has seen its stock fall by more than 85% since Welch stepped down in 2001.

America’s Experiences Bode Poorly for BABA

Daniel Zhang inherits a comparable situation at Alibaba. Its core retail business acts as a wildly successful version of eBay (NASDAQ:EBAY). That has slowly begun to change under the competitive threat from JD.com (NASDAQ:JD), which runs a more Amazon-like retail business. However, BABA followed Amazon’s lead by building a successful cloud business. Alibaba also works in artificial intelligence (AI), online payments, digital media, and entertainment.

Investors need to ask if Mr. Zhang can navigate all of these businesses at the same time. If the answer is yes, one can make a speculative case for Alibaba stock. However, other than Amazon in some areas, the experiences of American business with such firms indicate spinoffs could come in the future.

In an attempt to combine retail with payments, eBay bought PayPal (NASDAQ:PYPL). The online marketplace rethought that decision years later and today PayPal again operates as a separate company. In some ways, even Amazon’s experience does not bode well. Though Amazon runs an entertainment arm through Prime Video, it continues playing catch-up to Netflix (NASDAQ:NFLX). Also, outside of the Echo, Amazon has done little with AI.

These examples indicate that Mr. Zhang will face the same kind of challenges. Worse, if Zhang’s time at Alibaba mirrors that of former CEO Jeff Immelt’s tenure at GE, BABA stock may begin a gradual, multi-year decline.

Final Thoughts on BABA Stock

Due to its new CEO, Alibaba’s conglomerate status could create a danger separate from its political and accounting issues. Years ago, Alibaba ventured outside of its core retail business. It now works in fields unrelated to retail, such as entertainment and AI.

Given his success, Jack Ma had a vision and saw what could work in these multiple, disparate industries. The problem with businesses like this is finding a successor with similar talent. Jack Welch’s most significant failure at GE likely was an inability to find the younger version of him. Time will tell if Jack Ma can succeed where Jack Welch did not. Whether that answer is yes or no, investors need to weigh that threat when considering a position in BABA stock.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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