What Alibaba’s Hong Kong Upgrade Means for U.S. Investors

Once the go-to holding for U.S. investors into Asia, Alibaba Group Holding BABA (HK:9988) is now making good on a two-year-old promise to upgrade the ability for Chinese investors to access its shares.

Alibaba, the Chinese e-commerce market leader, has filed on Friday with the Hong Kong Stock Exchange to finalize a move that’s been in the works since mid-2022. It will upgrade its Hong Kong shares, converting the float into a primary listing, removing the “S” from its shares that indicated they were a secondary.

Alibaba went public on Wall Street in 2014. At $68 per share, it was the largest-ever initial public offering at the time, raising $25 billion including the over-allotment, on 368 million shares.

The company then floated a secondary listing in Hong Kong in 2019, bringing in another $13 billion. Since Hong Kong has a currency pegged to the U.S. dollar, the shares traded at equivalent values with little in the way of arbitrage potential.

Shareholders have, as of the August 22, 2024 annual meeting, now approved the plan, first mooted in July 2022, to convert the Hong Kong listing. The Wall Street and Hong Kong shares are now “dual primary” in nature, though this conversion doesn’t raise any capital or issue any new shares.

The change will be effective on August 28, 2024, making good on earlier indications that the company would complete the move by the end of August. There are some technical requirements for a primary listing in Hong Kong that differ slightly from what’s mandated for a secondary listing, but Alibaba shouldn’t have trouble meeting those new standards.

It has received a waiver from the Hong Kong Stock Exchange, for instance, to continue filing accounts under the U.S. Generally Accepted Accounting Principles (GAAP) system, whereas the local standard is to follow Hong Kong Financial Reporting Standards or the International Financial Reporting Standards that Europe uses. It will continue to prepare and file U.S.-style accounts.

Alibaba is also classified as having a weighted voting rights structure, since the Alibaba partnership, consisting mainly of its founders and top executives, has the exclusive right to nominate or appoint a majority of the board. The partnership also retains voting control over shareholder decisions. So it needed special dispensation to continue that in Hong Kong.

Hangzhou-based Alibaba continues to claim the largest market share for online trading in China, through its Taobao and upscale Tmall sites.

Alibaba shares ended slightly higher today, up 1.2%, better than the Hong Kong market as a whole, which fell 0.2%. Alibaba stock has jumped along a rocky road in moving 10.6% higher so far this year. That’s considerably better than the Hong Kong benchmark Hang Seng Index, which is up only 4.9% to date in 2024. Alibaba has narrowly outstripped the Hang Seng China Enterprises Index, up 9.6%, which tracks China-focused businesses listed in Hong Kong.

The company’s Hong Kong shares crested to a Covid-rally high of HK$298 in October 2020, and they’ve generated serial disappointment since. Investors watch every bull indicator for the Chinese economy to see if “this is the time” for Alibaba to launch a recovery rally. And, every time they’ve had hope, that’s been brought crashing down.

BABA shares on Wall Street tipped the scales at $310 at that all-time high in October 2020, since when they’ve descended as low as $64 in October 2022, less than one-quarter of the peak. They’re changing hands at $85 as of this writing.

What’s often missed amid the hand-wringing over the share-price performance is that Alibaba remains very, very profitable. Yes, its Q1 revenues missed estimates a week back, but the $33.5 billion figure was still up 4% compared with last year. Profits fell 1% from the same time last year but still tallied $6.2 billion.

Alibaba faces pressure from rivals such as JD.com JD (HK:9618) and relative newcomer PDD Holdings PDD, which runs the Temu app and online marketplace outside China and the site Pinduoduo inside China, which initially found its niche through group-buying discounts in smaller cities and rural China. What’s more, unlisted TikTok operator ByteDance, which operates the Chinese equivalent Douyin inside China, has also stolen a march on conventional e-commerce sites with its in-app purchasing.

But a greater challenge is the sluggish nature of the Chinese economy as a whole, and the apparent inability of the centralized government to turn it around. After a crackdown on overleverage, the housing industry has entered a tailspin that is proving extremely difficult to correct. With potential buyers losing confidence that an off-plan home will ever get built, the largest private-sector industry in China has ground to a halt.

We should watch for signs that the massive backlog of unbuilt homes can finally get completed before being confident the Chinese economy is truly in recovery mode. So far, Beijing’s efforts to backstop the property industry have met with a tepid response.

One key reason for the upgrade of the Hong Kong listing to primary status is that the shares can now participate in the Hong Kong Stock Connect. That initiative allows mainland investors to buy Hong Kong stock, even though there’s normally a “bamboo curtain” between mainland China’s heavily restricted financial markets and freewheeling Hong Kong.

Chinese shares change hands at higher multiples than those in Hong Kong, with the Shanghai market currently trading at a price/earnings (P/E) ratio of 12.2, according to CEIC Data, pricier than the average 10.2 P/E ratio in Hong Kong. That’s because mainland investors have few options for where to put their money, and even fewer high-quality stocks that are listed in Shanghai or Shenzhen.

Companies such as Alibaba set the trend to go to Wall Street to seek a global pool of investors. The upgrade of the Hong Kong listing brings Alibaba stock back home, where Chinese investors are more likely to believe the “China story.” As a result, Bloomberg estimates the listing change may result in inflows approaching $19.5 billion into the Hong Kong shares in the first six months that they participate in the stock-connect scheme.

That should boost the stock. But we’ll need to watch for recovery in China’s economy as a whole before 9988 and BABA soars again.

At the time of publication, McMillan had no positions in any securities mentioned.