Strategic trade
Trade view / 13 October 2015 at 0:19 GMT

Baidu-Alibaba spread to shrink as Singles' Day spree nears

China Watcher / Shanghai
China
Instrument: BIDU:xnas
Price target:
Market price:
Background

The world's biggest shopping event will be on November 11, with investors firmly focusing on the one-day sales figures from online retail giant Alibaba. After seeing $57.1 billion in sales on Singles' Day last year, the firm is set to smash its own record again, and this could be the pinnacle to what looks to be a very promising month for the firm.

Domestic Chinese equities and, as such, overseas listed Chinese firms have performed well since markets reopened after the week long Golden Week holiday at the start of October. Prior to Singles' Day, Alibaba is likely to report its calendar third earnings, where the majority of investor focus will be on the initial signs of Singles' Day results. This should take the pressure off new CEO Daniel Zhang, as recent earnings releases have been hit-and-miss.

One of the biggest potential drivers for Alibaba in the online retail space could become very evident during Singles' Day. As I discussed yesterday, the firm looks set to begin charging customers that want to guarantee the best deals; effectively selling call options for Singles' Day deals. This monetisation strategy will almost certainly be quickly adopted by Chinese consumers, as finding the best deals on Singles Day requires quick reactions, a very fast internet connection, and, most importantly, luck.

The benefits of holding Alibaba during this period seem abundantly clear, but to further leverage the potential returns of the trade, Baidu seems like a suitable short candidate. This is because it is the only one of China’s tech giants to not have any entity involved in Singles’ Day. Chinese online retailers see their equity valuations rally into the event, but Baidu likely won’t be a part of this, because it will have very little involvement at all, particularly when compared to its largest rivals Alibaba and Tencent, which is a stakeholder in Alibaba’s largest rival JD.com.

Given the prices of both equities, a suitable trade to take advantage of this would be to short one Baidu share and long two Alibaba shares. Given that this spread closed last night at $3.47 (Baidu over Alibaba), I expect that the spread will be trading at minus $7 by November 12 after Alibaba has announced its sales figures for the event.

Alibaba and Baidu share prices since Alibaba’s IPO last year
Alibaba and Baidu's share price history













Source: Stockcharts.com

Management

A major potential risk factor to this trade is that both firms are expected to announce their calendar third quarter earnings prior to Singles’ Day, which could affect the trade thesis. While I will provide more detailed earnings previews for both firms, the focus of the Alibaba trade view will be firmly on Singles’ Day, as well as the O2O mega-merger between the Alibaba-backed Meituan and Dianping.

Baidu’s earning release, on the other hand, will be more focused on the return on its billion-dollar investment in its proprietary O2O platform.

Chinese equities have been performing well over the past few days after domestic equities rallied on the back of strong consumer spending during the week-long national Golden Week holiday. However, as this year has proved, Chinese equities – both onshore and offshore – have been volatile. So any trade view involving Chinese equities has a higher volatility tendency than US companies.

Parameters

Entry: $3.47

Stop: $9

Target: -$7

Time Horizon: One month, ending November 13


— Edited by Robert Ryan

Non-independent investment research disclaimer applies. Read more

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