Breaking up Alibaba’s fintech empire — How real is the threat for investors?

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China’s investigation into the e-commerce conglomerate Alibaba is both shocking yet completely expected.

Following Alibaba’s co-founder’s lashing of Chinese regulators and insulting President Xi during a public address, China has escalated its campaign to rein the vast tech empire. An investigation into allegations of monopolistic practices by Jack Ma’s online retail giant has resulted in orders for his financial technology company Ant Group to scale back its operations. Ant must rectify illegal credit, insurance, and wealth management activities. These divisions are the business's fastest-growing and most profitable operations.

Ant’s highly anticipated IPO has been suspended.

The company’s shares have plummeted. Alibaba’s shares have lost more than a quarter of their value since 24 October. More than $10bn has been wiped from Jack Ma’s fortune knocking him into second place on the list of China’s richest people. The wealthiest person in China is now Pony Ma, the CEO of the rival tech firm Tencent.

Alibaba is the poster child for Chinese tech prestige, primed to take on the large US companies in a tech and geopolitical battle. This is a tactical question more than a regulatory question — how to balance Alibaba’s global reach and prestige while limiting its domestic power?

Source: Bloomberg

From the graph, it is clear that Ant and Alibaba control a sizable portion of the Chinese tech market — far beyond their respective focused areas of business.

Here are three possible scenarios that you should be aware of as an investor.

Scenario 1

In the best-case scenario, China could be bluffing to regain the fealty of Jack Ma. This could result in small to moderate fines as well as changes to the company’s business model.

Scenario 2

In a more severe scenario, Alibaba could be forced with a wind-down of its vast investment portfolio or face strict approval requirements before any further investments are made. The company may be subject to harsh rules regarding cross-selling and using its technology platforms and fintech platforms. This would be particularly devastating for Ant Financial as it would no longer be able to compete with state-owned banks.

In this scenario, Alibaba looks to be fairly valued at a 24 P/E ratio. The regulations and changes would have a long-lasting impact and handicap growth going forward. Nonetheless, the structure would remain largely intact and could adapt to the new rules and environment.

Scenario 3

In this nightmarish scenario — which has contributed to the massive decline in shares — the companies VIE (variable interest entity) structure would be compromised. If this occurs on top of the regulatory changes then the investment portfolio will plummet. It goes to say that if this scenario unfolds, Alibaba is completely un-investable and would plunge in both the USA and Hong Kong drastically until further clarity is achieved.

Looking forward

The most likely outcome is probably a mix of scenarios 1 and 2 i.e. small structural changes and fines. The changes will impact how Alibaba can work with its subsidiaries and companies in which it holds investments.

China has fired a warning shot and is looking to legitimately regulate its growing internet and tech space. Ant’s IPO is likely to be shelved until regulators get a firm handle on the company and limit structural risks to the Chinese economy as a whole.

To me, this looks like growing pains from a rapidly expanding internet economy wrapped up and instigated by Jack Ma’s comments and criticism.

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