Reasons behind Alibaba's listing in Hong Kong

People walk past an Alibaba Group sign in Hangzhou, East China's Zhejiang province, on May 10, 2018. (Photo: VCG)

Alibaba is listing in Hong Kong at a time when the city is heading for the first recession in a decade. However, three reasons explain how listing in Hong Kong will ultimately benefit the company in the long run.

Though the U.S. and China are now largely expected to reach a partial deal in the near future, the tension between the two may continue. Based on our knowledge, the current partial deal may only cover 60 percent of the entire trade deal that the Trump administration demands. If this information is reliable, it may be even harder for the two countries to reach a consensus on the remaining 40 percent.

Under such ongoing tensions, pricing for Chinese firms listed in the U.S. would be highly dominated by the progress of the trade negotiations instead of the individual companies' fundamentals.

Diversified portfolio, faster IPO process

Alibaba's stock price has been moving in tandem with the offshore yuan, one of the best indicators to gauge the trade tension since the beginning of the year.

Such an environment is definitely not favoring tech giants like Alibaba, who have a strong probability and a healthy balance sheet. According to Alibaba's earnings report, in the second quarter, net income came in at 72.5 billion yuan.

Its sales rose to 119 billion yuan, beating the earlier estimates, riding on better shopping recommendations, revamped grocery services and richer content such as livestreams. Revenue from the cloud computing business jumped 64 percent.

On Singles' Day shopping festival, Alibaba's Tmall turnover increased by 25.7 percent compared to that of a year ago, and Tmall's sales accounted for 65.5 percent of the total online consumption on that day, ranking first in the industry.

Trump's policy on China and its companies remains highly uncertain and unpredictable. Any unfriendly restrictions imposed by its administration on Chinese firms in the future cannot be ruled out. It's necessary for Alibaba to diversify its portfolio into other markets.

Hong Kong's IPO process is one of the fastest ones in the developed market, which may also be one of the important reasons behind Alibaba's decision.

Alibaba's B2B business was listed in Hong Kong in 2007, raising 1.7 billion U.S. dollars and delisted in 2013. Thus, the regulatory environment in Hong Kong may be more familiar for the Alibaba group. Besides that, issues such as more complex regulatory and valuation risks in its U.S. listing remain.

Increasing financing channels for Alibaba

Investors from the Chinese mainland have more "legal channels" to invest in the Hong Kong market than in the U.S. So, listing in Hong Kong will help Alibaba's stock to achieve a higher valuation.

After its listing in Hong Kong, investors from the mainland can buy Alibaba's shares. For Alibaba, the subscription of its IPO is expected to be overwhelming.

Financial companies accounted for around 50 percent of the Hang Seng Index. Hence, movement on the Hang Seng Index is more or less similar to equity in other financial sectors worldwide. Once Alibaba is listed in Hong Kong, the fund managers who cover the Hong Kong market are expected to diversify their portfolio into Alibaba as well.

Big financial firms could see their weightings cut by the Hang Seng index. Meanwhile, passive funds that track the Hang Seng Index weightings may also shift some of their portfolios into Alibaba's shares.

Valuations in U.S. stocks are stretched amid its weakening economic outlook

The risk of U.S. stocks facing a heavy sell-off will continue to rise in the coming years. The S&P 500 hit a record high on November 15. However, data shows its recent gains are not consistent with the U.S. economic fundamentals. U.S. stocks had been moving consistently with the ISM manufacturing PMI, but the two of them started to diverge since early this year.

The reason behind the divergence between the S&P 500 and U.S. manufacturing PMI is the Fed's rate cuts policy. However, the Fed signaled that it will pause the monetary easing for now. Without support from the Fed, the risk of a significant drop in U.S. stocks shouldn't be ruled out.

The Chinese mainland has also been heavily promoting its technology and innovation sectors in recent years. Its efforts in stemming the exodus of tech listings, such as the recent SSE STAR Market, could be interpreted as the government getting investors to support the technology sector.

Jimmy Zhu is the chief strategist at Fullerton Research.