Alibaba Group Holding Ltd (NYSE:BABA) founder and Executive Chairman Jack Ma has a lot of irons in the fire; nowhere is that truer than in his fight to take on Amazon.com, Inc. (NASDAQ:AMZN) in the global race for enterprise cloud computing dominance. Right now, it’s not even close — Amazon is leading by a country mile, but BABA is quickly closing the gap between the two and that’s a good thing if you own Alibaba stock.
Amazon entered the cloud computing business in 2006. Amazon Web Services (AWS) now generates more than $3.1 billion in operating income (fiscal 2016) from $12.2 billion in revenue, a juicy operating margin of 25.4%.
This was considerably higher than the $1.1 billion it generated from $123.8 billion (0.90% operating margin) in revenue from its e-commerce and Amazon Prime membership fees.
It’s easy to understand why BABA wants in on Amazon’s action — there’s lots of money to be made from the cloud.
What’s Going on With Alibaba Stock and the Cloud?
In Q3 2016, Alibaba went over the $1 billion annual run rate in cloud computing revenue generating $254 million from 765,000 paying customers, up 115% and 100% year-over-year respectively. Most importantly, its cloud computing business had an operating loss of just $49 million, 18.3% less than its Q2 2016 operating loss of $60 million.
That’s great news for Alibaba stock because at this rate, it should be in the black by sometime in fiscal 2017 and that will add to the already significant operating profits it generates from its core e-commerce business — $4 billion in the third quarter alone, a mouth-watering operating margin of 59.7%.
Put another way, BABA’s cloud computing segment along with its other money-losing businesses lost $976 million in the third quarter on revenue of $961 million; essentially, it lost a dollar for every dollar of revenue.
Alibaba generated $5.5 billion in operating profit through the first nine months of fiscal 2016 despite losses in other areas totaling $2.8 billion. Amazon generated $4.2 billion in operating income from more than 10 times the revenue.
There are many reasons why you might want to own Amazon’s stock (Jeff Bezos is a big one) but consider how valuable BABA stock would be were its cloud computing business generating operating profit margins similar to AWS.
Alibaba’s cloud computing business would go from an annual loss of $225 million ($169 million operating loss in Q3 2016 on an annualized basis) on $1 billion in revenue to an operating profit of $250 million on the same revenue, a $475 million difference.
“Our goal is to overtake Amazon in four years, whether that’s in customers, technology, or worldwide scale,” Simon Hu, the head of Alibaba’s cloud business told Reuters in 2015. “Amazon, Microsoft and others have already laid the groundwork for us by educating the markets about cloud in the U.S. and Europe, so we have an even better opportunity to join in the competition.”
Estimates put the global cloud computing business at $20 billion. However, given Amazon’s AWS revenue in 2016 was $12.2 billion, Microsoft Corporation (NASDAQ:MSFT) is coming on in this area and thought to be in the second spot behind AMZN and Alibaba’s annual run rate is over $1 billion, the number is likely much higher.
According to TechCrunch, Synergy Research Group analyst John Dinsdale revealed that “For cloud infrastructure services (IaaS, PaaS, Hosted Private Cloud services) Alibaba is now ranked sixth, based on worldwide revenues in Q4. For China specifically, while AWS and Microsoft are in the top five ranking in China, the market is led by Alibaba (a long way out in front) followed by China Telecom. Alibaba market share is running at 40 percent [in China] and has been increasing with time.”
Bottom Line on BABA Stock
Interestingly, the fact that BABA stock was late to the cloud computing party, might actually work in its favor because large companies are far more open to working in the cloud these days than they were a decade ago when Amazon got in the business.
Therefore, you could argue that the company’s investment in the cloud, albeit several billion dollars, is still far less risky than Amazon’s initial moves back in 2006.
While there are many tentacles to the Alibaba stock, cloud computing is one that will continue to reap dividends for BABA stock in the years to come.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.