Why Cloud Computing Will be a Key Revenue Driver for Alibaba

Alibaba has consolidated its leadership in China’s cloud computing market and will continue to expand its cloud market share at a rapid pace.

Male IT Specialist Holds Laptop and Discusses Work with Female Server Technician. They're Standing in Data Center, Rack Server Cabinet with Cloud Server Icon and Visualization

Image source: Getty Images

Shares of China’s technology giant Alibaba (NYSE: BABA) have largely outperformed the market this year before a recent pullback that has still left the stock up over 20% year to date. But what has driven the company’s stock higher? Alibaba continues to post solid results despite a sluggish domestic economy and the ongoing trade war between the U.S. and China.

Here, we’ll look at Alibaba’s fastest growing business segment and why it will be a key revenue driver going forward.

The huge market opportunity for Alibaba

We can see below how cloud computing revenue outpaced gains from the company’s other business segments such as core commerce and digital media & entertainment in fiscal 2019 (which ended in March):

Segment Fiscal 2018 Revenue % of Revenue Fiscal 2019 Revenue % of Revenue YoY Growth
Core Commerce $34.1 billion 85.5% $48.2 billion 85.8% 41.2%
Digital Media & Entertainment $3.1 billion 7.8% $3.6 billion 6.4% 15.0%
Cloud Computing $2.1 billion 5.4% $3.7 billion 6.6% 72.4%
Innovation Initiatives & Others $0.5 billion 1.3% $0.7 billion 1.2% 32.5%

Data source: S&P Capital IQ. Table by author.

Alibaba will be banking on cloud sales to help drive growth going forward. In the June quarter, the company’s cloud computing revenue maintained its rapid expansion, growing 66% year over year to $1.1 billion and accounting for 7% of sales. This growth was driven by an increase in average revenue per customer.

The company launched over 300 new products and features in the second quarter with a focus on delivering value-added services to expand its customer base and increase enterprise engagement. Management aims to expand market leadership by increasing investments in research and development as well as investing heavily to attract the best human capital. In fact, in fiscal 2019, Alibaba increased its R&D spending by 64.5% — those expenses accounted for 9.9% of sales in 2019, up from 9.1% of sales in 2018.

Alibaba is also targeting growth by expanding its SaaS (software-as-a-service) offerings. It wants to work in collaboration with SaaS partners and build an ecosystem to provide exceptional service to enterprises.

China’s cloud computing market accounts for over 25% of the global total and continues to grow at a rapid pace. According to market research firm Canalys, China’s cloud infrastructure services market grew by 58% year over year to $2.3 billion in the second quarter of 2019.

Competition from tech giants

Alibaba led China’s cloud market with a share of 43% at the end of the second quarter. Tencent and Baidu held 17.4% and 8.7% shares of the market, respectively. Globally, Alibaba is competing with tech heavyweights like Amazon, Alphabet, and Microsoft. Gartner previously estimated Alibaba’s IaaS (infrastructure-as-a-service) public cloud revenue growth at 92.6%, which was the highest among top players in 2018, besting impressive figures from Amazon (26.8%), Microsoft (60.9%), and Alphabet (60.2%).

One reason Alibaba will continue to grow cloud sales at an enviable pace is due to its traction among China’s top companies. At the end of 2018, over 40% of China’s top 500 companies and over 50% of the country’s listed companies were on Alibaba Cloud. The company has successfully established itself as the primary public cloud platform for businesses across all industries in China (and importantly, 80% of the region’s startups).

The verdict

China’s 800 million internet users and the rapid transition to 5G will result in exponential data growth that will need to be stored in a secure environment. These tailwinds will drive demand for cloud services, providing a huge opportunity for Alibaba and its peers. China’s cloud computing market is estimated to grow from $14 billion in 2018 to $25 billion in 2022, according to China Daily.

Though the cloud computing segment is still unprofitable, the company will aim to see bottom-line contributions from this segment in the near future. Investors need only look at Amazon Web Services, which made up less than 15% of revenue but 69% of total operating profit for the e-commerce giant in the most recently reported quarter. Alibaba will look to replicate its rival’s success in turning the cloud into one of its key profit drivers as it benefits from economies of scale.

With demand for cloud services in China and other Asian economies growing, the segment will make up an increasing share of Alibaba’s sales, and if profitability can expand in tandem with the top line, the stock still has plenty of room to run.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Aditya Raghunath has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Baidu, Microsoft, and Tencent Holdings. The Motley Fool has the following options: long January 2021 $85 calls on Microsoft. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.

More on Tech Stocks

edit Woman calculating figures next to a laptop
Tech Stocks

How to Buy UiPath Stock in Canada

UiPath is a beaten-down AI stock that trades at a massive discount to its earnings growth. Is the tech stock…

Read more »

A shopper makes purchases from an online store.
Tech Stocks

Is It Still Prudent to Invest in Shopify Stock?

Let's dive into whether Shopify (TSX:SHOP) remains a top TSX stock investors should consider, or if this company may be…

Read more »

edit Businessman using calculator next to laptop
Tech Stocks

Which TSX Stock Is Best to Buy Today? 

The stock market is going green with optimism over hopes of economic recovery. You can benefit from this rally with…

Read more »

A close up color image of a small green plant sprouting out of a pile of Canadian dollar coins "loonies."
Tech Stocks

Tech Treasures: 2 Undervalued Software Stocks to Watch

These two software stocks have a bright future, according to analysts, and a bright present for investors getting in on…

Read more »

Growth from coins
Tech Stocks

2 Growth Stocks I’d Buy in July 2024

Here's why quality growth stocks such as Datadog should help you deliver outsized gains in the upcoming decade.

Read more »

consider the options
Tech Stocks

Is it Too Late to Buy Celestica Stock Now?

Celestica (TSX:CLS) stock has seen shares surge by 289% in the last year alone! But is growth over? Or could…

Read more »

woman retiree on computer
Tech Stocks

2 Top TSX Growth Stocks to Buy Today and Hold for 10 Years

Given their long-term growth prospects and discounted valuations, these two growth stocks could deliver multi-fold returns in the long run.

Read more »

hot air balloon in a blue sky
Dividend Stocks

3 Roaring Stocks to Hold for the Next 20 Years

Sure, there are stocks roaring upwards in the last year, but these three can claim doing it for decades.

Read more »