The Chinese government's investigation of Alibaba (NYSE: BABA) has sprawled into multiple areas. It started with CEO Jack Ma's criticisms of Chinese financial regulators who were looking at Ant Group like a bank rather than a tech company. However, the investigation is now also targeting Alibaba for "monopolistic" business practices.
This has cooled sentiment among Chinese Internet stocks, as the regulatory risk wasn't considered a factor. Another second-order effect is that certain companies may preemptively make moves to stay out of regulators' crosshairs. So, it's not surprising that the second-largest ecommerce company in China, JD.com (Nasdaq: JD) is considering a spinoff of its cloud computing and AI units.
Spinoff Logistics
Shares moved 3.9% higher on the news. Although ecommerce sales are growing rapidly, cloud computing and AI have an even faster growth rate with the potential for even higher multiples. According to sources, the transaction would mean that the new entity would be "better positioned to deliver a suite of cutting-edge technology services to its business partners, while the Company will continue to focus on its core competencies and synergistic businesses to better serve customers."
The move would also remove concerns from customers that there could be a conflict of interest between JD and its clients. There is also the possibility that JD could spinoff other units like JD Logistics and JD Health.
Stock Price Outlook
Currently, JD derives a significant majority of its revenues from ecommerce. However, other parts of its business are growing at faster rates. It's certainly benefited from the coronavirus which caused an acceleration in online sales all over the world. This translated into the stock gaining 146% in 2020.
Regarding 2021, its prospects are less certain. On the bearish side, many believe that ecommerce sales could see some dip due to an increase in in-store retail sales. It also seems likely that 2021 will feature better than expected economic growth which would lead to a rotation from growth stocks into value stocks this could also be bearish for Internet stocks like JD.com. By all sorts of historical metrics, growth stocks are overbought, overowned, and overvalued, while value stocks are at extremes on the other end. Either, there will be a rotation, or we are in a new paradigm where these relationships are no longer valid.
On the bullish side, spinoffs of multiple divisions could unlock higher valuations. Additionally, the long-term outlook for the industries that JD has been remain bright with double-digit compounded annual growth rates. Additionally, industries like health IT, AI, and cloud computing remain early in the growth cycle especially in Asia where penetration is much lower.
One way to reconcile this conflicting picture is that the long-term trend remains up, but 2021 will present some dips and weak performance which will set up as attractive entry points for the long-term.