Alibaba out of the cloud business after Beijing undermined its potential

(Bloomberg) — Alibaba Group Holding Ltd.’s surprise move to expand a potentially transformative $12 billion cloud business is fueling speculation about whether the Chinese e-commerce leader is bowing to the market or to political realities.

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CEO Daniel Zhang dropped a bombshell on Thursday when he unveiled the contours of Alibaba’s historic six-way shake-up for the first time. Among the listing and financing of a large number of companies was a plan to completely relinquish control of the business known as Alibaba Cloud, a once thriving operation that included the ability to grow the company faster the way Amazon Web Services grew to mean the Amazon.com company.

The crux of the issue is why Alibaba has chosen to cut a business that some analysts estimate at more than $30 billion, and is a major beneficiary of a post-ChatGPT boom that relies on cloud resources to train the next generation of AI models. In doing so, it sheds a unit that comes with historical baggage and its own share of uncertainty in the business. Alibaba shares fell 5.9% in Hong Kong on Friday, after disappointing Chinese trade numbers were also reported.

China’s most valuable e-commerce company has invested tens of billions over more than a decade in the online corporate computing hosting business. For years, one of Alibaba’s proudest and often-touted achievements was a company that outperformed competing offerings from Tencent Holdings Ltd. and Baidu Inc. , grew more global flavor than any other division, and led significant internal initiatives.

But government scrutiny of cloud services run by private companies intensified around 2020, when Beijing became suspicious of privately owned repositories of sensitive and valuable data, prompting a now-infamous widespread crackdown on the internet sphere. AliCloud itself sparked regulatory fury in 2021 for discovering and then sharing a major software flaw before reporting to authorities, and was then investigated in 2022 for its role in China’s largest known cybersecurity data leak. The cloud division has in recent years begun to erode its market share in favor of competitors including Huawei Technologies Co. and China Mobile Ltd.

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“It’s a positive for shareholders because it’s a great return on capital, but once the cloud business is fully distributed, you no longer add to Alibaba Holdco’s valuation,” said Vey Sern Ling, managing director at Union Bancaire Privee. “The company says the cloud business is relatively independent and unrelated to the core e-commerce business. But investors may be wondering if the government has asked them to separate.”

Read More: Alibaba Breakup Starts With $12 Billion Cloud Strike

Key points of the breakup chart

• Alibaba plans to spin off its cloud services division as a separate entity by distributing shares to shareholders over the next year

• This means that Alibaba may eventually end up not owning shares in China’s largest cloud services platform

• It will aim to float its Cainiao logistics arm in 12 to 18 months

• Immediately, the company aims to complete the Freshippo grocery chain’s IPO within the next year

• It plans to secure outside funding for its international trading division, which includes overseas operations such as Singapore-based Lazada

Like Amazon, Alibaba’s cloud service emerged from the computational power needed to handle millions of online shopping transactions simultaneously. But unlike its American counterpart, it enjoyed a field advantage in a vast Chinese market where Web-based computing was (and still is) new to many companies. Its push to the cloud, where software and services are delivered to customers via server farms the size of football fields, was envisioned as helping to shield Alibaba from local shocks to its core operations.

Zhang said Thursday that the cloud arm is largely running itself as an independent operation. But it’s also inextricably intertwined with some of the company’s most pivotal undertakings.

Cloud holds its own Singles Day themed party, an annual event that showcases the company’s massive global reach in online shopping. It helped run hundreds of thousands of transactions per second — a massive endeavor that Alibaba credits its cloud division for enabling. The unit contributed to profit for the first time around late 2020, helping to buoy the bottom line just as the shocks of the Covid-era affected shopping. It houses the DAMO Academy, which is working on potential groundbreaking projects from chip design to quantum computing.

Read more: Scrutiny of Alibaba breach of record case may disqualify All China Tech

In fiscal 2022, the company generated nearly $12 billion in revenue – 8% of turnover. It was so significant that in March, when Alibaba first revealed its six-party break-up, Zhang personally headed what he called the Cloud Intelligence department — seemingly indicating that he was destined for greater things.

“This whole spin-off plan involving AliCloud is both bold and bewildering,” Nomura Holdings Inc analysts Jialong Shi and Thomas Shen wrote in a note. Their current valuation of the unit is about $31 billion. “AliCloud is a core business for BABA and continues to be one of the long-term drivers of the group despite its growth having temporarily slowed in recent quarters due to macro headwinds. Which is why we find it baffling that BABA decided to spin off this company entirely rather than retain at least a minority stake. “.

The tide had turned against business several years earlier. Beijing’s crackdown on former tech giants since late 2020 has pushed risk-averse enterprises toward state-owned service providers.

Bloomberg News reported that large companies such as the China Construction Bank and local municipalities in cities like Nantong were already closing in on state-backed cloud platforms.

In the end, Alibaba probably agreed on business considerations. Zhang said that the purpose of single withdrawals is to simplify the structure and respond to market needs. He told analysts on Thursday, without elaborating, that a standalone platform could one day grow to overtake Alibaba in size if it attracts the right external financing.

“The planned rollout comes at a challenging time for the cloud business, which appears to have lost the initiative for growth,” said Robert Lea, analyst at Bloomberg Intelligence.

Read more: The unraveling of Alibaba’s $32 billion-a-day Chinese tech behemoth

– With the help of Vlad Savov.

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