(Michael Li and Shalin Kothari)
Recent tensions stemming from the US towards large Chinese Internet corporations have been evident in the media. The president’s recent order banning TikTok, owned by Beijing’s ByteDance, from the United States has been heavily scrutinised due to its unprecedented nature and wider implications for over 80 million active users in America. This, in conjunction with the recent decision to essentially prevent Huawei from obtaining US designed chips and semiconductors, has been the latest of a series of relentless attacks on Chinese companies over the threat of US intellectual property and personal data protection from the Communist Party of China (CPC). The Shenzhen Stock Exchange (SZSE) dropped 10% when both TikTok and WeChat were outlawed, and this seems to be only the beginning with Baidu and iQiyi shares plummeting last week over impending SEC investigations.
This highlights the key role politics plays in company performance and future growth and poses intriguing questions for investors regarding the impact of a Biden victory and how China will fight back from all this. Our job as analysts is to give you context, our insight and ultimately our recommendation and this week the focus will be on US politics and Chinese Internet Companies.
|Baidu Inc (BIDU)||31/12/2016||31/12/2017||31/12/2018||31/12/2019||Latest|
|Price/Free Cash Flow||21.92||18.96||14.13||13.93||12.87|
|Return on Equity %||12.86||17.70||16.65||1.18||1.43|
|Earnings Yield %||8.62||3.19||7.91||0.63||0.76|
|Enterprise Value ($Bn)||51.36||71.95||50.41||33.49||30.23|
|Price/Free Cash Flow||22.74||26.65||19.83||23.68||28.46|
|Return on Equity %||13.21||18.37||14.54||24.30||19.16|
|Earnings Yield %||2.26||2.09||2.86||3.88||3.14|
|Enterprise Value ($Bn)||221.83||439.56||362.16||551.91||669.66|
As of 21st August 2020 Baidu (NasdqGS:BIDU) are trading at $122.45 (Simply Wall St., 2020), successfully rebounding from their 5-year low share price of $83.62 on 18th March 2020. The recovery has been largely V-shaped, and the stock is on track to return to pre-covid levels of $144.51 per share. There was a brief shock to prices on the 14th of August following an SEC investigation into a whistle blower report by Wolfpack Research suggesting that company books and user numbers were manufactured. Shares briefly dropped to just over $116 per share but now have recovered making this is a key development that investors should track.
Alibaba Group Holding (NYSE:BABA) have seen their stock rise consistently over the past 5 years with the most recent (22nd August) share price standing at $265.80, an all-time high for the company. As a tech giant who can be compared to as the Amazon of China, Alibaba have seen limited knock on effects from COVID with a very sharp recovery from early 2020 until now. This is due to the increase in online demand following strict lockdown measures in China which have seen share prices rise. Furthermore, revenue from its cloud computing division rose 58% to $1.7 billion as they are closing in on Google in terms of global market share.
These are examples of large Chinese internet companies that could become the next target of the Trump’s campaign. Since the US-China trade war emerged ideas of delisting Chinese stocks from US stock exchanges have been prominent (Navellier, 2020). This would be catastrophic for investors and shareholders, but the good news is that delisting is a long and legislative process that needs to go through the House of Representatives. The recent SEC investigation of Baidu shows that the company is also on the federal radar and could be victim to a new wave of onslaught. Furthermore, Alibaba’s cloud dominance could force aggressive actions to derail the project, like with Huawei and 5G, as the US will want to maintain their dominance in this sector due to worsening relations and a lack of trust towards the CPC.
The first immediate concern for investors is the highly volatile price/earnings (P/E) ratio for Baidu, whilst the P/E ratio for Alibaba is generally a better representation of the industry. The tumultuous effects of Covid-19 have shaken investor earnings significantly, directly impacting Baidu’s P/E ratios. As a result, the P/E ratio is heavily inflated as of now. Perhaps a more useful metric is the price-to-book ratio (P/B), which has proven to be much more stable in the recent period. This more accurately reflects the value of assets on the balance sheet and here, it offers reassurance for investors. Alibaba continues to be significantly more expensive than Baidu, as Baidu’s P/B approaches a value below 1 having decreased consistently in the last few years. Any P/B ratio below 1 is generally considered a sensible investment, so in this respect, we would generally avoid buying Alibaba’s stock.
Looking at the price/sales (P/S) ratios, we can see the impact of Covid-19 and US political tensions more so in Alibaba than Baidu. Baidu’s P/S ratio has steadily declined from the end of 2018, whereas Alibaba has increased by almost 50% in the same period. In this respect, Baidu seems to be performing promisingly, as a lower P/S ratio indicates the company is undervalued. This is largely due to the recent decline in Alibaba’s revenue for Q1 of 2020. A worrying sign for investors as it suggests the market cap for Alibaba is relatively inflated.
But this ratio alone should not concern investors too much as these 2 giants of China’s internet market have proved to be relatively stable in comparison to other smaller organisations. The concern for many investors should be how revenues may be affected in the near future given the volatile conflict between China and the US. Alibaba has put a recent focus on expanding their business internationally (especially competing with the likes of Amazon in the US). With over 180 million active customers internationally (Budd, 2020), the conflict is likely to have negative ramifications on the firm and its investors. We could potentially see a further decline in EBITDA and enterprise value. Baidu also shows a similar story, although revenues did not decline as significantly as Alibaba in the last year, the EBITDA decreased from over $3.5bn to $0.45bn, which is a worrying decrease. In a recent interview, Trump signalled that the US may look beyond TikTok and Huawei in terms of banning Chinese tech companies in America (Feng, 2020). The international future of these tech giants could take huge hits, which has caused investors to put share prices under the microscope.
Having said this, if we look at stock prices over the last 5 years, both stocks plummeted around mid-March due to growing concerns from Covid-19. This presents an opportunity for investors, Baidu and Alibaba’s stock price have plateaued in their recovery from this low, and whilst they may well go down as a result of this conflict between the 2 largest economies in the world, they will almost certainly deliver returns in the long-run. This is simply because of the growing importance of tech/internet companies. Both Baidu and Alibaba are still delivering relatively healthy profits and so should be able to take this short-term loss, and we have seen that conglomerates like Google and Amazon have been among the most profitable stocks for investors in recent years. Given the size of China’s market, it seems extremely unlikely that either of these companies will continue to struggle in the long run.
Despite the current hostile climate, these firms they are still more than investable due to their strength globally. China has come a long way in the past few decades in terms of ability to innovate and rely on domestic technology. It is certain that China’s ascension had much to do with the open-door policy and American support but recent US focus on Huawei is partly attributed to the fact that the company is jeopardising US innovation. The progress made by Huawei in many ways showed the world that China is becoming a serious power in the world technological advancements with critics arguing the American response is out of fear of being overtaken rather than proven Huawei wrongdoings. This shows that perhaps Chinese firms will be able to bounce back even with a loss in US markets. Looking a Baidu their immediate recovery from the SEC investigation highlights that the firm is highly resilient and built on strong foundations, whilst Alibaba’s strong growth and rebound from Covid has also been more than convincing for any potential investors. In an ideal world these companies have all the potential for healthy projections and are a definite buy.
However, in this week’s report it is imperative to look at the impact politics can have on the aforementioned companies and in our opinion their fate hinges on the US election result. The influence of America over the rest of the world is apparent with Britain pulling out of 5G deals with Huawei and global chipmakers cutting ties with Huawei all as a direct result of US orders. There is every reason to believe that this could happen to either Baidu, Alibaba or any company that comes across their radar meaning for investors it is necessary to be more alert than ever. We believe this could be temporary situation, as China is one of Trump’s main election focuses, but with a Biden victory the situation could reverse. It is possible that he will seek to integrate US markets globally and improve relations once again which will ease the tensions and allow Chinese companies to thrive once more. This is all highly speculative as although opinion polls look to be in favour of Biden, one can never rule Trump out.
Overall, there is too much political uncertainty surrounding the likes of Baidu, Alibaba and all wider Chinese internet companies until the presidential situation in America becomes clear. But if we isolate the politics both companies are projected to grow steadily as they are making excellent progress internationally, internally as well as making headway in different industries.
Budd, J., 2020. Trump hints at banning Alibaba after enforcing action against TikTok. [Online]
Available at: https://www.channelweb.co.uk/news/4019092/trump-hints-banning-alibaba-enforcing-action-tiktok
[Accessed 19 August 2020].
Feng, C. Q. T., 2020. Chinese tech giants face mounting pressure from the US government – will Baidu, Alibaba be next to get hit?. [Online]
Available at: https://www.scmp.com/tech/big-tech/article/3097689/chinese-tech-giants-face-mounting-pressure-us-government-will-bat-be
[Accessed 19 August 2020].
Investopedia, 2020. Definitions. [Online]
Available at: https://www.investopedia.com/
[Accessed 22 August 2020].
Navellier, L., 2020. Alibaba Stock Will Keep Growing Despite New Delisting Threats. [Online]
Available at: https://investorplace.com/2020/06/alibaba-stock-coronavirus-growth-delisting-china/
[Accessed 21 August 2020].
Simply Wall St., 2020. Baidu. [Online]
Available at: https://simplywall.st/stocks/us/media/nasdaq-bidu/baidu
[Accessed 21 August 2020].
- Price/Sales Ratio: The price-to-sales (P/S) ratio is a valuation ratio that compares a company’s stock price to its revenues. It is an indicator of the value placed on each dollar of a company’s sales or revenues.
- Enterprise Value/EBITDA (EV/EBITDA): Enterprise multiple, also known as the EV multiple, is a ratio used to determine the value of a company. The enterprise multiple looks at a firm in the way that a potential acquirer would by considering the company’s debt. tocks with an enterprise multiple of less than 7.5x based on the last 12 months (LTM) is generally considered a good value.
- Enterprise Value: Enterprise value (EV) is a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. EV includes in its calculation the market capitalization of a company but also short-term and long-term debt as well as any cash on the company’s balance sheet. Enterprise value is a popular metric used to value a company for a potential takeover.
- Price/Earnings ratio: The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). P/E ratios are used by investors and analysts to determine the relative value of a company’s shares in an apples-to-apples comparison. It can also be used to compare a company against its own historical record or to compare aggregate markets against one another or over time. (Investopedia, 2020)
- Price/Book ratio: Companies use the price-to-book ratio (P/B ratio) to compare a firm’s market capitalization to its book value. It’s calculated by dividing the company’s stock price per share by its book value per share (BVPS). An asset’s book value is equal to its carrying value on the balance sheet, and companies calculate it netting the asset against its accumulated depreciation. (Investopedia, 2020)
- EBITDA: EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure of a company’s overall financial performance and is used as an alternative to net income in some circumstances. EBITDA, however, can be misleading because it strips out the cost of capital investments like property, plant, and equipment. (Investopedia, 2020)