Alibaba’s Stock Review: Discounted Price with High Risks

Overview

Alibaba Group Holding Limited (NYSE:BABA) is currently trading at a significant discount compared to its US counterparts. The company’s net cash and investments make up 75% of its market cap. However, despite this discount, there are concerns regarding the strong competition it faces from domestic peer Pinduoduo, the potential for regulatory intervention, and geopolitical risks. In this article, we will explore Alibaba’s current situation and how call options can be used to manage downside risk while retaining upside exposure.

Key Challenges

1. Competition from Pinduoduo: Alibaba’s e-commerce segment, Taobao and Tmall Group, remains its primary cash driver. However, Pinduoduo’s Pinduoduo platform is experiencing significant growth, with top-line growth rates outpacing Alibaba. This domestic competition poses a threat to Alibaba’s market share and profitability.

2. Geopolitical and Regulatory Risks: The potential for regulatory intervention and geopolitical tensions could impact Alibaba’s stock performance. These risks may lead to a lack of confidence among investors, contributing to the stock’s discount.

3. Delays in Business Spin-Offs: Alibaba has abandoned plans to IPO its Cainiao logistics segment, opting instead to repurchase minority stakes. This shift in strategy may impact Alibaba’s plans to realize shareholder value through separating its businesses.

Stock Valuation and Performance

Despite the challenges, Alibaba’s stock remains undervalued, trading at less than 9 times this year’s earnings estimates. The company has a strong net cash position and significant equity investments, which contribute to its discounted market cap. Alibaba’s share repurchase program and international business segment growth offer some positive outlooks.

Options Strategy to Manage Risk

Given the potential risks, investors can use call options to reduce downside exposure while retaining upside potential. Here’s an example strategy:

• Purchase a call option expiring in January 2026 with a strike price of $50 for around $26.30 each.
• Replace a 100-share position in Alibaba (worth approximately $6,900) with one call option for $2,630.
• Retain the remaining $4,270 in cash or invest it in high-quality bonds.

This strategy limits the potential downside to 38% instead of 100% for a common equity position. It also retains substantial upside exposure while providing almost two years of options time.

Conclusion

Alibaba’s stock presents an attractive valuation due to its discounted price and strong cash position. However, risks related to competition, regulatory challenges, and geopolitical issues cannot be ignored. Using call options can be an effective way to manage these risks while still benefiting from Alibaba’s potential upside. Investors should carefully consider these factors when evaluating an investment in Alibaba.