Why Alibaba’s Cloud Ambitions Fell to Earth
Several months ago, executives at Alibaba tried to persuade some big investors to take a stake in its cloud unit—which Alibaba was then planning to spin off as a separate company—at a $40 billion valuation. Alibaba’s idea was that the outside investments could signal to the stock market the appeal of the cloud unit ahead of its public debut.
The plan flopped. Investors balked at the valuation Alibaba sought. They were conscious that the cloud business—though the biggest of its kind in China—was barely growing and was also losing money. One international investment firm, for example, was only willing to offer a valuation of less than $25 billion for the unit, according to a person with knowledge of the discussions. The episode underlined for Alibaba executives the fact that the spun-off cloud unit would not be well received by the market, contributing to the company’s decision announced last week to cancel the move.
THE TAKEAWAY
• Investors balked at $40 billion cloud valuation sought by Alibaba
• Many Chinese customers don’t want to pay for public cloud services
• Alibaba’s hopes of emulating Amazon’s diversification were dashed
The plan’s failure also demonstrated that Alibaba’s hope of offsetting slowing growth in commerce with diversification in cloud services has failed. Alibaba had hoped to emulate Amazon, which over the past 20 years has built its cloud unit, Amazon Web Services, into its biggest source of profits. Alibaba, though, is struggling with the reality that businesses in China don’t want to pay much for public cloud services and other software.
Even Alibaba’s own commerce operations pushed back at what the cloud unit wanted to charge for its services after the company spun off the cloud unit, said people familiar with the situation. Alibaba Cloud and the e-commerce business disagreed over the terms on which they would do business after a spinoff, the people said. It has not been reported previously that the failed fundraising attempt and the internal wrangling contributed to the scrapping of Alibaba Cloud’s spinoff.
Alibaba blamed the decision on U.S. export restrictions placed on chips, which will hurt Chinese cloud providers’ ability to offer artificial intelligence–powered services using Nvidia’s specialized AI chips. Alibaba didn’t comment on questions sent by The Information.
While most internet companies in China, and some big corporations such as automakers, have embraced cloud computing to run their own operations, many other domestic enterprises, especially in traditional industries such as manufacturing supply chains, coal, energy and chemicals, have shown little enthusiasm for cloud adoption, analysts say. Many of those companies use their own servers and storage located on their own premises, and it is difficult to convince them that the benefits of cloud computing outweigh the costs of migrating from the current setup.
Alibaba remains the biggest cloud computing service provider in China’s domestic market. In the third quarter, Alibaba’s market share stood at 39%, followed by Huawei’s 19% and Tencent’s 15%, according to research firm Canalys. But the growth of China’s cloud computing market as a whole has slowed sharply, lagging the global market, according to Canalys.
Spooked Investors
The unexpected cancellation of Alibaba Cloud’s spinoff, along with the company’s decision to delay the initial public offering of its grocery chain, Freshippo, spooked Alibaba investors. After falling 10% on the day the spinoff was canceled, Alibaba’s market capitalization of about $200 billion is down more than 75% from an all-time high three years ago. These events threw into question the future of Alibaba’s largest restructuring in its 24-year history, announced earlier this year, which would have split the Chinese internet giant into six parts and rejuvenated its growth.
Alibaba’s top-line growth has flatlined over the past three years. In the last fiscal year through March, the company’s revenue growth slowed to 2%, from 19% in the previous year and 41% the year before that. Revenue from the China commerce business, which accounts for nearly 70% of Alibaba’s total revenue, declined 1%, compared to an 18% increase in the previous year. The company’s e-commerce business has been grappling with intense competition from growing rivals such as Pinduoduo and ByteDance, which has turned its Douyin video app into a major online shopping platform for Chinese consumers.
The expansion of cloud services, once a major driver of the company’s growth, has slowed down dramatically in the past few years. In the last fiscal year through March, the unit’s annual revenue grew 4% to 77.2 billion yuan ($10.9 billion), down from 23% growth in the previous year and 50% the year before that. Meanwhile, the cloud unit lost 5.15 billion yuan ($726 million).
The unit’s pace of growth remains slow. In the September quarter of this year, its revenue rose 2% to 27.6 billion yuan ($3.89 billion). Alibaba said it intentionally reduced the unit’s sales from low-margin contracts in the quarter as part of its efforts to focus on profitability. Alibaba executives have said the proliferation of AI software in China will create a major opportunity for the cloud unit. At the company’s annual tech conference in Hangzhou last month, Joe Tsai, Alibaba co-founder and chair, said about half of China’s conversational AI software, known as large language models, is using Alibaba Cloud.
The flattening growth happened at a tumultuous time for Alibaba’s cloud unit, which hasn’t had a permanent leader since the departure of Daniel Zhang in September. Zhang, then CEO of both Alibaba and the cloud unit, stepped down from both positions. Zhang, who became Alibaba’s CEO in 2015, was facing growing doubts about his leadership from some of Alibaba’s managers as well as investors, The Information reported last year. Since then, Eddie Wu, who replaced Zhang as Alibaba’s CEO, has been serving as interim CEO of the cloud unit. Zhang has moved on to establishing a technology investment fund, which will receive a $1 billion commitment from Alibaba.
Washington’s efforts to limit U.S. semiconductor exports to China, especially the Nvidia chips powering the development of AI, create an additional challenge for China’s cloud service providers, which already are grappling with sluggish growth. In China, all major domestic cloud providers, including Alibaba, Huawei, Tencent and Baidu, are developing their own LLMs, while also helping their cloud customers create new AI applications using those models.
The U.S. chip export control seems to have hit Alibaba harder than its Chinese peers. Tencent said this month that its chip stockpile is large enough for the company to continue developing its LLM “for at least a couple more generations.” Baidu said it has a “substantial reserve” of AI chips that will enable it to keep improving its chatbot for the next year or two. Alibaba didn’t make a similar declaration.