Should investors be concerned about Alibaba’s antitrust issues?

Alibabais (NYSE: BABA) Shares recently tumbled after the company was hit by a triple hit from antitrust action. First, China’s SAMR (State Administration of Market Regulation) fined Alibaba for its unapproved acquisition of the department store chain InTime Retail.

Just over a week later, SAMR launched an antitrust investigation into Alibaba’s e-commerce business and its use of exclusive deals to block merchants. The agency also called Ant Group, Alibaba’s fintech affiliate, which originally planned to go public in November, for a regulatory meeting.

Those three hits wiped out nearly all of Alibaba’s earnings as of 2020. Are investors overreacting to headlines, or could SAMR cause major headaches for China’s leading e-commerce and cloud company?

Investors should have seen it coming

CNBC’s Evelyn Cheng recently said the actions against Alibaba were “largely unexpected,” but the writing has been on the wall for a long time.

SAMR introduced antitrust laws in 2008, but those rules were primarily aimed at foreign companies and hardly affected domestic tech giants like Alibaba. But in early 2020, SAMR announced that it would amend those rules to crack down on domestic companies.

In April, SAMR drafted stricter rules for large acquisitions. In November, it drafted additional rules that would focus on price discrimination, exclusive deals for merchants in online marketplaces, and the mandatory collection of user data. All those redacted rules seemed to point to Alibaba.

Meanwhile, Alibaba co-founder Jack Ma fell out of favor with the Chinese Communist Party (CCP) despite being a registered member. Ma was frequently critical of the CCP’s policies, and his recent criticism of China’s banking systems allegedly prompted regulators to suspend Ant’s long-awaited IPO. All of those developments were red flags for Alibaba investors, so they shouldn’t. surprised by your recent antitrust recognition.

Alibaba’s rivals have complained for years

Alibaba controlled 55.9% of China’s e-commerce market last year, according to eMarketer, followed by JD.com (NASDAQ: JD) (16.7%) and Pinduoduo (NASDAQ: PDD) (7.3%).

For the past three years, JD and Pinduoduo have complained about Alibaba’s use of exclusive deals to block merchants. Merchants who listed their products on Alibaba’s Tmall were allegedly penalized with downgraded listings and bans if they sold the same products on JD and Pinduoduo. Therefore, SAMR’s crackdown on exclusive e-commerce agreements is not too surprising.

Should investors be concerned?

Two of the three recent developments won’t hurt Alibaba as much. First, the SAMR only fined Alibaba 500,000 yuan ($ 76,548) for its unapproved acquisition of InTime Retail, which is a drop in the bucket for a company that is expected to generate $ 107.4 billion in revenue this year.

However, the token fine could make it difficult for Alibaba to expand its physical business, which complements its e-commerce markets, improves its logistics network and links more buyers to Ant Group’s Alipay payment platform.

Ant Group’s suspended IPO could have generated a lot of cash for Alibaba, which owns a third of the fast-growing fintech company. The additional restrictions against Alipay could also soften its defenses against its main rival, Tencentis (OTC: TCEHY) WeChat Pay.

Alibaba’s stake in Ant generated 7.72 billion yuan ($ 1.12 billion) in investment earnings, or 10% of its net income, in the first half of fiscal 2021. The value of that stake would have risen significantly after the IPO of Ant, but also won ‘t decline simply because the offer was suspended. Instead, Alipay will likely maintain its duopoly with WeChat Pay in China.

The only SAMR move that could significantly harm Alibaba is a total ban on exclusive deals with merchants. Alibaba generates most of its revenue and all of its profits from its core trading business, and removing those prisoner-capture deals would allow brands to list their products in JD, Pinduoduo, and other smaller e-commerce marketplaces.

Alibaba has already relied on lower-margin businesses, such as brick-and-mortar stores, direct sales channels, cross-border e-commerce platform, and its logistics subsidiary Cainiao, to make up for the slower growth of its huge Taobao and Small Markets. The new restrictions could exacerbate that pressure.

The key findings

Some investors may dismiss SAMR stocks as short-term headwinds. However, these actions have been telegraphed for almost a year and the agency appears determined to slow down Alibaba’s growth.

Alibaba is trading at 17 times future earnings, which is a low valuation compared to its estimated earnings growth of 37% this year and 21% next. Stocks look cheap at these levels, but I would stay away until the new SAMR restrictions are finalized and we can fully measure the financial impact. Until then, we shouldn’t rely on analysts’ forecasts, most of which were made before the government set its sights on Alibaba.