In the past few quarters, Alibaba (NYSE:BABA) has shown good growth numbers from its cloud segment. In the recent quarter, Alibaba reported $962 million of revenue in cloud computing with year-on-year growth of 84%. This is a highly stable business with the potential for good margins as shown by Amazon’s (NASDAQ: AMZN) AWS. The impact on BABA stock is also quite significant.

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Hence, Alibaba’s management has announced its intention of focusing on the cloud to drive future growth. Alibaba CEO, Daniel Zhang, has also mentioned that cloud would be the main business of the company in the future.

But due to the trade tensions and the negative impact of the Huawei fiasco, we could see additional scrutiny on Alibaba’s cloud expansion in several international regions. Financial Review has recently mentioned the security challenges faced by Alibaba in its cloud push in Australia. Similar issues will arise in Europe, Canada, India and other regions.

BABA Stock and the Importance of the Cloud Segment

The Cloud Computing segment of Alibaba is the fastest-growing segment for the company. In the recent quarter, the revenue from this segment was RMB 6,611 million or $962 million, up from RMB 3,599 million in the year-ago quarter. Hence, the revenue share of cloud computing increased from 4% to 6%.

The EBITA margins for this quarter down 4%. This was a slight improvement from the 5% loss in the year-ago quarter. Although all companies do not separately report their cloud revenue, Alibaba’s revenue pace puts it among the top players of cloud business. Alibaba is rapidly setting up new data centers in international regions. It has recently opened two new data centers in the U.K. and another in Indonesia. We should see a number of new openings in Europe and South Asia over the next few quarters.

Alibaba has the capacity to invest substantial amounts to improve the long-term growth potential of its cloud business. The company can also decide to forego profits in the short term to provide more attractive pricing to customers. This should improve the market share and revenue growth at a rapid pace.

Last year, Wells Fargo’s Ken Sena estimated the standalone valuation of Alibaba Cloud to be around $80 billion. If we look at the total growth potential, the valuation could easily top $150 billion. This is over one-third the current market cap of Alibaba. Hence, any negative impact on cloud computing will hurt the bullish sentiment around Alibaba stock.

Impact of Trade Rhetoric and Huawei Issue

Even if there is a win-win deal on trade issues between the U.S. and China in the near term, the brand image of Alibaba Cloud could take a beating. In addition, the Huawei issue is still unresolved. The sentiment against Huawei can be seen in a statement made by T-Mobile’s CEO John Legere. He said, “Let me be clear — we do not use Huawei or ZTE network equipment in any area of our network. Period. And we will never use it in our 5G network.”

Corporate clients who are procuring equipment are more risk-averse. They would like to prevent any upsetting of the business due to changes in the regulatory environment. The cloud computing business is different from the 5G network, but it also requires big contracts worth millions of dollars from corporate clients. If these cloud providers want a risk-free cloud provider, they would always have an alternative to choose Amazon’s AWS or other tech companies.

The top management from Alibaba is yet to make a statement on this issue as they would be waiting for a favorable trade deal. However, investors need to look at the possible impact of these challenges on Alibaba stock.

Alibaba’s Options

Alibaba is trying to add new clients by aggressively pricing its cloud services. We can see this from the huge difference in the margins of Amazon’s AWS and Alibaba Cloud. In the recent quarter, AWS posted an operating margin of 29.3%, while Alibaba Cloud showed an EBITA margin loss of 4%. The company can continue to lower its prices in the near term to provide heavy discounts to clients compared to AWS.

Alibaba has also formed a strong partnership with Europe’s biggest department store, El Cortes Ingles. Alibaba would be providing payments supports, logistics, e-commerce and new retail options to the Spanish company. But the most important part of this partnership for BABA is the ability to add another big client for its cloud program. Having bigger brands on its client list should make it easier for BABA to add new clients in the future.

Alibaba is also a big cloud player in China where Amazon and Microsoft (NASDAQ:MSFT) are very small. If a foreign brand wants to have a presence in China, Alibaba Cloud would be the first choice. This gives the company a starting point to explore additional cloud service for these brands in their home country.

Impact on Valuation

The growth potential of the cloud business in China is itself quite big. Hence, Alibaba will continue to deliver decent growth due to its domestic cloud services in China. But a few major hiccups in international regions could reduce the long-term potential for Alibaba Cloud. This should also impact the valuation of the company and the momentum of Alibaba stock.

BABA stock is currently trading at a forward price-to-earnings multiple of around 27. This is quite low for a company with revenue growth that’s close to 40% and experiencing improvement in EBITDA margins. However, a big part of BABA’s valuation is tied to its ability to show continuous growth and improvement in margins in the cloud business. Investors need to watch the possible challenges faced by this segment to gauge the future momentum in BABA stock.

Bottom Line on Alibaba Stock

Alibaba Cloud could face security concerns similar to Huawei as it expands in international regions. The current U.S. administration has put pressure on allies to ensure that sensitive national infrastructure does not use Chinese technology. This will limit the usage of Alibaba Cloud in many areas. It also negatively impacts the brand image of Alibaba Cloud. Corporate clients who are risk averse would rather pay a premium to get AWS or other cloud providers instead of using Alibaba Cloud.

A long-term trend toward poor reception for Alibaba Cloud will limit the revenue growth of this segment in international regions. It will also force BABA into giving bigger discounts to lure clients which should reduce the margin expansion within the cloud segment. The cloud segment plays a vital role in the bullish thesis for BABA stock. Hence, it would be important to see how its management deals with any additional security concerns regarding its cloud business.