Chinese President Xi's e-commerce clampdown 'is not regulatory, it's personal,' analyst says

John Freeman, CFRA Vice President of Equity Research, joins Yahoo Finance Live to break down Alibaba's earnings amid China's crackdown on tech and e-commerce companies.

Video Transcript

- Well, we want to get back to the markets and start with Alibaba, that stock down about 9% to 10%. And we have John Freeman here-- he's the CFRA vice president of equity research-- to help us break down this report. And John, revenue full-year guidance-- this is a killer-- lowered to 20% to 23% from about 30%. What went wrong, and why did everybody seem to miss this?

JOHN FREEMAN: Well, thank you for having me, by the way. I think a lot of people are-- you know, haven't-- you know, haven't missed it, I think. I'm not the only one who, you know, who's gone through a sell rating. I went to a sell rating on Alibaba in January, and then strong sell in August. It's a confluence of things, right?

The results are certainly disappointing. And I was actually-- I actually expected the results to be better. And I'm kind of surprised the stock is not down more because if you look at the organic growth rate-- that is, without the Sun Art acquisition-- China commerce only grew 14% year over year. And the guidance, it's a little unclear how Sun Art fits into that, but the guidance was 23% year-over-year growth, probably lower organic. And you know, this is a company that has been growing, you know, 30% and 40% over the last couple of years on the commerce side. And cloud has also been a very strong grower, at the 50% level. And now, it's-- you know, last three quarters, it's been much lower, 29% growth, and you know, blamed on a cloud customer that it lost.

All of this comes back to, I think, the Chinese macro economy, the pressures on that. And also, just generally speaking, I think that the-- what Xi Jinping is doing, the clampdown, it's not regulatory, it's personal. And he's taking out the leaders of these companies. It's a real gamble, I think, to bet on the shares of Alibaba that are traded on our exchange, the NASDAQ.

- So John, when you talk about this 12-month price target that you have, $118 a share, a significant downside to where it's trading today, how much of that downside that you see comes from what you've described as a crackdown from Xi Jinping directly? How much of that is about the weakness we're starting to see in consumer spending in China?

JOHN FREEMAN: So I think it's mostly the former, but increasingly the latter, right, with these results. I think there's probably a good, I don't know, 20% to 30% chance that-- and this, I'm not sure how widely understood this is, but the SEC now has a mandate, they must, as part of the Sarbanes-Oxley legislation, and then some legislation was passed last year, they have to perform audit reviews on all companies, you know, foreign companies included, that review the auditors, right? So every three years. And that deadline's coming up in about a year and a half.

And I think, you know, and Xi Jinping has not backed down. He says, we're not doing that. You can't do that. So and the risks-- so there's actually a delisting risk. But I think Xi Jinping actually might, you know, act preemptively to just say the Alibaba shares are null and void. And then all of the-- the only shares that are, you know, that are valid are the ones trading in Hong Kong, right?

And so that would-- you know, that would be a substantial transfer of value, I suppose, obviously residual value, because, you know, it would get hit everywhere. But these kinds of things you don't want to be really dealing with as a research analyst, you know? And you have to kind of put-- I should say as well, there's a good chance that that happens. And then, you know, US shareholders would be really, really hurt. I think that, you know, you have to be-- if you want to get into this, you have to be really risk-tolerant. And it is a speculative buy at this point. And I continue to maintain, reiterate my strong sell.

- On the specific crackdown that we're seeing domestically, what does that mean from an operational standpoint for Alibaba? On the one hand, we've seen the government talk about increasing competition to Alibaba, as well as other rivals can't really get into these exclusive contracts that they have on their platforms. But as an investor, how should they be thinking about this company? Is this just about slower growth with more in check from the government, or is it about a fundamental shift that's likely to happen as a result of the regulatory pressures that are going to continue?

JOHN FREEMAN: I think the shift is happening. I think, you know, it has happened and is happening, and will happen even more. So from that perspective, obviously the government does play favorites, right? So it is able to influence buying and influence all kinds of other aspects of your business. So it is not the kind of environment that we normally think of here. It's not the kind of environment that we normally thought of even in China previous to 2013. And so that's a real black box.

And you know, that's why I think that, without some substantial regime change or some-- you know, not necessarily the Chinese Communist Party, that's probably not going anywhere, but there's got to be some major changes in the way that-- in the direction of totalitarianism, which, you know, it's really there. I mean, they're already there. That's not a great-- you know, software-based businesses are driven by innovation, and innovation doesn't really, you know, happen, it doesn't really occur freely in that kind of situation. And there can be a lag time, right? There could be still companies that are innovating and doing things, but over time, it really puts a damper on it. And I think we're already seeing the results on that on Alibaba, particularly even on the profit side.

- You know, before we go, I wanted to get your thoughts on Baidu. They just released earnings the other day. Another disappointment. They're down 28% year-to-date, much more off of their peak. Anything to add there?

JOHN FREEMAN: Basically, well, I've treated both of those the same since the Ali-- since the Ali-- the Ant IPO cancellation last year. That started it all, right? And that was-- you know, they call it regulatory, but at the moment, they didn't call it regulatory. They were talking about financial risk and these kinds of, you know-- this kind of thing with Ant. But it was really because Xi Jinping didn't like what Jack Ma said at a conference, right, and was offended by, you know, Jack Ma's recommendation, very sort of soft advice, hey, I think we should probably, you know, reform our financial regulations to allow more fintech innovation.

And then you haven't heard from him, you know, for-- you didn't hear from him for three months. I mean, you know, so Baidu the same way. Baidu got hit with a lot of this crackdown in 2015 and when Xi Jinping first took over. Although not quite as dramatic as, you know, as the canceling of the IPO, but Baidu, as well, has been under the pressure of the-- of Xi Jinping's regime, particularly to basically kind of suppress the internet search business, which we all know is very lucrative, right? We've seen what Google did, right? And Baidu was the Google of China. But now, it is really trying to diversify away because Xi Jinping doesn't want people to be searching for stuff, right?

- Well, and it looks--

JOHN FREEMAN: Right? I mean, that's the-- that's the-- that's the core of it.

- And it looks like he's going to have an unprecedented third term to oversee all of that. We're going to have to leave it there, but John Freeman, thank you for your time. CFRA vice president of equity research.

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