A few weeks ago, the SEC added Ali Baba (NYSE: BABA, OTCPK:BABAF) to the list of companies threatened with delisting from US stock exchanges for non-compliance with the Holding Foreign Companies Accountable Act (HFCAA). In October I have wrote an article titled Alibaba: prepare for possible delisting in which I explained why there is a real possibility that Alibaba shares will be delisted for the foreseeable future. At the time, there was a lot of skepticism from various investors about a possible delisting, as it would make no sense for Alibaba to break the rules and miss the opportunity to continue raising funds. in the most liquid capital market in the world.
However, Alibaba seems helpless in this situation since, without Beijing’s blessing, it cannot allow international auditors to audit its books. At the same time, while discussions between US and Chinese regulators have been ongoing since late 2021, no major breakthroughs have been made to date. As a result, SEC Chairman Gary Gensler is reluctant to send auditors to China and Hong Kong before a deal giving full access to Chinese companies’ books is reached.
Considering that China-US relations are at an all-time low following the visit of US House of Representatives Speaker Nancy Pelosi, the chances of striking an audit deal seem dim at this stage, which makes more possible delisting from Alibaba in the foreseeable future. At the same time, unless a deal is reached, shares of Alibaba will likely continue to trade at distressed levels, especially considering the fact that in addition to external risks, the company also faces internal pressures at home due to poor results. which he just pointed out. For these reasons, it’s hard to justify owning Alibaba even at current prices.
Radiation is a real concern
One of the main reasons the SEC added Alibaba to the list of companies at risk of debarment is that the PCAOB was unable to fully audit the company’s fiscal year results for the year to come. ending in March 2022. Even though PwC’s Chinese and Hong Kong branches audit Alibaba’s reports every year, the company has been consistently added to the list of companies located where authorities deny access to conduct inspections. In the past, the SEC even filed an administrative lawsuit against PwC’s Chinese subsidiary for not providing documents, while the PCAOB said the following about not carrying out comprehensive inspections in the country:
The PCAOB has devoted considerable time and resources to negotiating a Memorandum of Understanding (MOU) with Chinese authorities for enforcement cooperation. Unfortunately, since the signing of the MoU in 2013, Chinese cooperation has not been sufficient for the PCAOB to obtain timely access to the relevant documents and testimony necessary to carry out our mission in accordance with the fundamental principles identified above. , and the consultations undertaken within the framework of the memorandum of understanding did not lead to improvements.
With the passage of the HFCAA nearly two years ago, Chinese companies have up to three years to give listeners full access to their books after the first warning or face delisting from US stock exchanges. However, efforts have been made to shorten this timeframe, so there is always the risk that Alibaba could be delisted even sooner than many investors expect if lawmakers change the law. Although the company is eager to remain on US exchanges and issued a statement earlier this month that it will comply with all applicable laws, in reality it will not be able to do so until an audit agreement will not have been concluded between the American and Chinese regulators. is reached.
The problem is that regulators on both sides of the Pacific have been in talks since late 2021 and have reached no agreement so far. While Chinese officials throughout the spring hinted that a deal was on the horizon, SEC Chairman Gary Gensler cast doubt last month on whether a deal would be struck soon. At the same time, he also said that the US side would not agree to an agreement that included restrictions of any kind and that he would not send inspectors until regulators had agreed. on how to move forward.
On top of that, PCAOB President Erica Williams in an interview earlier this month mirrored Gary Gensler’s statement saying that the organization will need to have full access to Chinese companies’ books in order to conduct an inspection. thorough. At the same time, she reiterated that it was important that the deal be reached quickly, as many more steps will need to take place before inspectors can start checking the Chinese books and reach a conclusion.
Another SEC director, YJ Fischer, agrees that timing is key since the deal is only the first step to resolving the delisting issues. Earlier in May, he said an audit agreement needed to be reached quickly so the PCAOB could complete all necessary investigations in early November to draft a ruling and vote to fulfill Congress’s mandate. Here is his direct quote:
Even if an agreement is signed between the PCAOB and the Chinese authorities, it will only be a first step. The PCAOB must be able to obtain sufficient cooperation and agreement from Chinese authorities for the PCAOB Board of Directors to determine that it can fully inspect and investigate in China and Hong Kong.
In 2021, the PCAOB already published a report on its determinations in which it concluded that it could not access the books of Chinese companies even though HFCAA had already been active for a year. He’ll likely say the same thing in his 2022 report, as it looks like an audit deal is a long way off.
The main issue at this stage is whether Beijing is ready to give full access which could include any sensitive information since the US side will not be able to agree on a deal that includes restrictions. Considering that after Nancy Pelosi’s visit to Taiwan, Beijing cut off contact with Washington on vital issues and agreed to military exercises with Russia, it seems the SEC Chairman is right when he doubts a agreement is concluded in the foreseeable future.
As a result, Alibaba investors are likely to continue to suffer, as one of the main risks will remain with the stock for some time until a deal is reached or the stock is delisted. While Alibaba has decided to minimize the downside by making a primary listing in Hong Kong, which is expected to be completed by the end of 2022 and provide additional options for mainland Chinese investors to invest in the company, this does not will still not solve the fundamental problems, which will continue to put pressure on its actions. At the same time, the exodus of international investors continues, with Bridgewater becoming one of the last major funds to close its position on Alibaba.
It is also important to note that it is wrong to blame the weak performance of Alibaba shares on the overall market sell-off. The internal and external issues the company is currently facing are the main reasons why its shares are trading at distressed levels and have lost around 44% of their value in the last 12 months, while the NASDAQ index is almost stable for the same period. It is unlikely that without the deal, Alibaba’s stock could rise significantly and beat the index for the foreseeable future.
Risks for the thesis
It is obvious that an audit agreement could change the whole situation, neutralize delisting fears and boost Alibaba shares. This article has highlighted the latest developments, which indicate that regulators are unlikely to reach an agreement anytime soon, but there is always the risk that the situation could change in an instant and any investor should be aware of this. .
On top of that, Alibaba’s stock is a fundamentals-only buy. My DCF model from a few months ago showed that the company’s fair value is $152.34 per share, while the current consensus price target is $152.7 per share. As a result, Alibaba’s stock is up about 70% from current levels based on fundamentals alone. The problem is that the company has been trading below its fundamental fair value since late 2020 after Beijing began its crackdown on the company. As a result, Alibaba could continue to trade low for a long time due to constant internal and external risks that make it difficult to justify going long, even at current levels.
Most of the geopolitical developments from 2022 so far indicate that an audit deal is unlikely to be reached anytime soon, as talks between regulators have been ongoing since late 2021 without any major progress. On top of that, there is also a risk that U.S. lawmakers will shorten the time frame for the SEC to enforce the delisting of stocks from U.S. stock exchanges, allowing Alibaba to lose access to the world’s most liquid capital market sooner than expected. a lot. investors think. Therefore, I continue to believe that it is difficult to justify a long position in the company, even at the current price, until the external regulatory risks are neutralized.