I have written a couple (I, II) of favorable articles on Alibaba (NYSE:BABA). However, some recent developments are taming my positivity. This article is about those developments.
This new risk is the one which concerns me the most. The risk regarding cloud services is that the Chinese State, administration and State-linked companies are favoring State-linked telecom companies (as well as Huawei) when it comes to cloud deployments. This development massively favors the 3 large Chinese telecoms – China Mobile, China Telecom and China Unicom. As a result, these companies have been seeing very large growth on what are already large cloud businesses, and are taking share from private companies such as Alibaba.
For instance, the following is official commentary on the Chinese telecom sector (the 3 large Chinese telecoms named above) growth when it comes to cloud services (bold is mine):
In breakdown, the revenue for cloud computing services soared 138.1 percent year-on-year, while that for big data and Internet of Things surged 59.1 percent and 23.9 percent, respectively.
These aren’t small competitors, either. Right now, it’s estimated these 3 companies taken together already control nearly 20% of the market, and continue growing much faster than the market itself:
Compare this to what Alibaba reported last quarter (which refers to the same quarter commented above):
In the quarter ended March 31, 2022, revenue from our Cloud segment, after inter-segment elimination, was RMB18,971 million (US$2,993 million), an increase of 12% year-over-year. Year-over-year revenue growth of our Cloud segment was slower in March quarter compared to prior quarters, reflecting slowing economic activities, softening demand from customers in China’s Internet industry and delays in delivery of hybrid cloud projects due to the impact of COVID-19.
Not only is this dynamic unfavorable to Alibaba in terms of market share, but it’s also creating viable cloud competitors which will then potentially steal other customers (outside of the State sphere).
Finally, all of the Chinese telecoms are quoted in Hong Kong and Shanghai, and their stocks now provide cloud exposure at massive discounts. The 3 telecoms all trade at incredibly low EV/EBITDAs (in Hong Kong), all below 1.2x, versus ~8.8x for BABA.
For investors, this risk can be significant. It creates a headwind to Alibaba cloud growth. It creates pricing pressure in the cloud services market. And it creates alternative investments which are much cheaper and actually outgrowing Alibaba in the cloud market – which is often part of the thesis to own Alibaba itself.
Another problem, somewhat related to the above, is that Chinese stocks have been punished extensively. The reasons have been many (non-exhaustive list):
- The drop in US tech stocks
- The firmer regulatory environment in China
- The fight on COVID
- The Ukrainian conflict, which made the world look at China and fear it could do the same in Taiwan
- An economic slowdown in China, partially provoked by slowdown in real estate.
Some stocks were hit harder and earlier by these effects than others. Alibaba was among the first, having been hit hard by the firmer regulatory environment as well as issues around Jack Ma. Other stocks were hit later and to different extents than Alibaba. The result has been that some other stocks have become relatively cheaper than Alibaba, while being exposed to similar factors as Alibaba when it comes to their growth.
This also created alternative investments to Alibaba – which aren’t limited to the Chinese telecoms listed before.
Digital Yuan / e-Yuan / eCNY
A smaller risk with extreme potential to grow is the creation of the digital Yuan by the Chinese State. The digital Yuan is the same as cash issued by the Chinese Central Bank, and has recently seen very large growth in terms of the number of users. From 24.4 million wallets in June 2021, it grew to 261 million wallets (1/5th of China’s population) as of December 2021, even while still being restricted to specific pilot regions / cities.
The adoption and acceptance of digital Yuan at merchants is explosive, as besides it being official money (which theoretically can’t be refused), and there being some moral suasion leading to its adoption even at the leading competitors (WeChat, Alibaba) there’s yet another big advantage: Its payment commissions are much lower (zero to start), and are set to remain much lower, than those asked by competing payment services.
That said, this challenge by central digital money in China is less significant than it would be in other countries — simply because the fees charged by the payments leaders including AliPay amount to just 0.55% of the sale value.
Over time, this means that there’s potential for existing payments processors (including Alibaba’s Alipay) to lose market share. Also, as the digital Yuan gains share, there’s the potential for pressure on payment fees (at least restricting their potential growth).
Finally, China has a powerful incentive in making the digital Yuan spread not just inside but also outside China, as it could work as a mitigator in case sanctions blocked Western payment networks to it.
However, it should be said that in the short-term this risk might not be scary enough for the market to care. Alipay’s rumored IPO might see much more interest than this longer-term threat.
On The Plus Side
China should be nearing a near-term economic inflection point. The COVID fight is loosening up, and the real estate crisis is being lapped up from last year, while economic stimulus is increasing. Car sales seem to have bottomed already, and the rest of the economy likely faces a H2 2022 acceleration.
Alibaba is so large in eCommerce, that an economic acceleration would tend to favor it no matter what the competitive factors might be. Hence, this potential for economic improvement is a large positive factor for Alibaba.
At present, I’m becoming less positive on Alibaba because of these new risks, especially the cloud risk.
It seems to me that better alternatives now exist when it comes to exposure to the Chinese market or for investments in general, due to these risks.
I still think Alibaba remains undervalued. But the alternatives are more undervalued still, while often sharing the same growth potential and catalysts as Alibaba itself, or even greater potential growth if we restrict ourselves to cloud segments alone.