Although Chinese tech stocks are probably one of the most unloved parts of global stock markets right now, it’s also worth taking a step back and looking at the actual businesses.
One of those companies under the microscope in China has been Alibaba Group Holding Ltd (NYSE: BABA) (SEHK: 9988).
Alibaba also happens to have a dominant presence in the cloud computing market in China through its Alibaba Cloud business.
In the US, most of us will be aware that the two leading players in cloud computing, Amazon.com Inc (NASDAQ: AMZN) and Microsoft Corporation (NASDAQ: MSFT), make incredible amounts of money from the sector.
However, given the size and depth of the US market it’s understandable. China’s cloud market is still young, though.
So, beyond the headlines, is Alibaba’s cloud business actually just a younger version of Amazon?
Strong revenue growth but small base
Alibaba’s cloud business (known as Alibaba Cloud) racked up impressive growth in the fourth quarter fiscal year 2021 (for the three months ending 31 March 2021).
It posted 37% year-on-year growth to RMB 16.76 billion (US$2.59 billion). What’s more relevant in terms of showing the size of the business, though, is how much it contributed to Alibaba’s overall top line.
And it’s here where investors can see how small this business is currently. Alibaba Cloud contributed only 9% of Alibaba’s overall revenues of RMB 187.39 billion during the quarter.
It’s useful to make a comparison. Alibaba is the leading cloud player in China. As such, it is often compared in that vein to Amazon’s Amazon Web Services (AWS), which is the current global leader.
However, AWS posted revenue of US$13.5 billion in the first quarter of 2021– over five times that of Alibaba Cloud.
Today, AWS generates just 12% of Amazon’s overall revenue yet contributes nearly half of its operating income.
Barely profitable
Meanwhile, in Alibaba’s case, it was still an unprofitable business until very recently.
In its latest quarter, Alibaba Cloud actually saw an adjusted EBITA of just RMB 308 million, up 487% year-on-year from a loss of RMB 179 million in the same period in 2020.
As Alibaba Cloud continues to spend and scale its capabilities, it should become more and more profitable. In fact, Alibaba Cloud only turned profitable in the second half of 2020.
Converting enterprises over the long term
Alibaba will no doubt be focused on converting enterprises (basically large businesses) to become clients of its cloud platform.
That model has already seen widespread success as Amazon and Microsoft have shown in the US.
China’s cloud computing market is big and growing fast. In 2020, the size of the global public cloud services market was estimated to be US$312.4 billion, up 24.1% year-on-year, according to IDC.
Compare that to China, where it grew faster than the global average – reaching US$19.4 billion in 2020, up 49.7% year-on-year.
Keep betting on the cloud
At first glance, Alibaba’s cloud business can easily be seen as insignificant given the size of its overall business.
For longer-term investors, though, the cloud business could be one of the key profit drivers in future – similar to how AWS is for Amazon today. And China’s cloud market will keep growing, no matter what happens politically.
If we assume that Alibaba is a few years behind the US giants, then the profits should eventually flow down to the bottom line, benefitting both the company and shareholders.
Disclaimer: ProsperUs Head of Content Tim Phillips owns shares of Microsoft Corporation.
