Key Takeaways:

• Alibaba plans to spin off its T-Head unit for a separate listing amid high market valuations for AI chip makers
• LVMH is handing over its Greater China duty-free operations to a state-owned enterprise as the sector struggles with declining financials

image credit: Bamboo Works

Today we examine two major strategic shifts involving global giants navigating the complex Chinese market. On one hand, we have a push by Alibaba (NYSE:BABA) into the overheated semiconductor sector, and on the other, a strategic retreat by LVMH (MC.PA) from the Chinese retail travel space, both reflecting how companies are adapting to capital demands and state-dominated market structures in China.

We start with the semiconductor industry, specifically the rush for AI chips, or GPUs. These components, once largely in the domain of gaming computers, now power capital-hungry AI models, lifting Nvidia (NASDAQ:NVDA) to stratospheric heights. Chinese companies are eager to join the fray. Alibaba is considering a spinoff and separate listing for its T-Head unit, which makes AI chips, just a year after scrapping a broader plan to split the company into six parts.

Alibaba is the second internet major to explore this path, following a similar move by search giant Baidu (NASDAQ:BIDU) last year. We believe valuations are a clear driver here. The market for AI chips is strong, but the industry requires enormous amounts of capital — tens to hundreds of billions of dollars — to build the infrastructure that promises to revolutionize our lives. While Alibaba has significant financial resources, spinning off T-Head makes sense to attract third-party external capital to fund this expensive growth.

However, we must look at the valuations with a critical eye. Currently, listed Chinese AI chip companies trade at triple-digit P/S ratios despite being unprofitable. By comparison, Nvidia — which is profitable and dominates the sector — trades at a P/S ratio of only 24. We think the Chinese market functions on different beliefs than Western markets; AI is the currently "hot property," and investors are willing to pay valuations that are not really justifiable anywhere outside China.

The government's desire for "national champions" to reduce reliance on Western chips ensures there will be plenty of domestic competition. However, history in the China market suggests that when competition saturates a sector — as seen with EVs and solar panels — it usually doesn't end well. While a listing in Hong Kong might offer more realistic pricing and access to foreign capital compared to the A-share market in Shenzhen or Shanghai, it is hard to feel comfortable with triple-digit valuations for unprofitable ventures.

Luxury meets state control

Switching gears to the consumer sector, we look at a significant deal in the luxury space. LVMH has handed off operations of its Duty Free Shoppers (DFS) business in Greater China to the locally run China Tourism Group Duty Free Corp. (1880.HK; 601888.SH). As part of the $400 million deal, LVMH will become a shareholder in the Chinese company, while China Tourism Group acquires DFS stores in Hong Kong and Macao, along with brand rights in Greater China.

This appears to be a retreat for LVMH, but we believe it highlights a strategic mismatch. Duty-free shopping, which attracts bargain hunters, is the opposite of true luxury goods, which rely on high margins, exclusivity, and emotion. Real luxury brands, like Hermes, do not discount their products in duty-free shops. Furthermore, the duty-free business in China is primarily a state-owned affair. With Hong Kong and Macao firmly within China, this deal represents a state-owned enterprise (SOE) buying from a private luxury house. Whether this was a strategic decision by LVMH to exit a non-core business or a result of political pressure to cede ground to an SOE remains an open question.

The backdrop for this deal is a struggling sector. Despite aggressive government promotion to turn tourist favorite Hainan Island into a duty-free haven, China Tourism Group saw its revenue and profit fall between 16% and 20% in 2024. We hear constant proclamations about liberalizing rules, yet the financial reports suggest these policies haven't done much for the company's top or bottom lines. Ultimately, LVMH may be securing cash and a strategic stake, but the synergy of such a merger is often corporate jargon used to justify spending shareholder money. We will have to wait for future financial reports to see if this realignment pays off, but for now, the data suggests the "booming" duty-free narrative conflicts with a harsher reality.

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China Inc by Bamboo Works discusses the latest developments on Chinese companies listed in Hong Kong and the United States to drive informed decision-making for investors and others interested in this dynamic group of companies.

Benzinga Disclaimer: This article is from an unpaid external contributor. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.