Would Alibaba Cloud Follow AWS' Growth Trajectory
Both Alibaba and Amazon are E-commerce giants, first movers of Cloud and distant public IaaS leaders in their respective countries. Would Alibaba Cloud be an AWS-like revenue grower?
Three years after AWS was launched, Alibaba made its cloud computing technologies available to external clients in 2009. Alibaba Cloud offers comprehensive cloud products comprised of elastic computing, database, storage, security, web hosting, AI, IoT and so on. Its pricing model is the simple pay-as-you-go, requiring no long-term commitments. Based on Garner’s estimate, in 18H1, Alibaba Cloud ranks the first in domestic IaaS public cloud market (41% market shares) and the third globally (3%), followed by AWS (38%) and Azure (6%). Having secured a dominant position in the bottom layer of the software stack, IaaS, Alibaba Cloud is working on moving up the stack and expanding its PaaS and SaaS solutions.
Key question: is Alibaba Cloud the AWS five years ago?
Although AWS’ revenue is currently 12x that of Alibaba Cloud, with an operating margin of 28% (vs. negative margin of Alibaba Cloud) and much larger R&D investments, both Amazon and Alibaba are E-commerce giants, first movers of Cloud and distant public IaaS leaders in their respective countries. They share the same vision of cloud being the main revenue/margin drivers in the long term. Below, we illustrate a few more similarities between the two cloud businesses in detail.
Similarity #1: Business evolvement
Originally intended to serve start-ups and small technology firms, AWS has increasingly adopted by the largest companies in the world and its notable customers include GE, Pfizer, Adobe, Netflix, and NASA. In the cloud area, it is said that 20% of enterprise customers can contribute as much as 80% sales. Likewise, Alibaba Cloud initially served small-sized E-commerce businesses, where Alibaba owned more of the expertise and demonstrated its cloud strength via the success of Nov.11th Chinese Shopping Festival. After building its reputation on SME, Alibaba expanded to larger enterprises, including Ford, SAP, Cathay Pacific and KPMG, as well as developed a relationship with public sectors (i.e. became the official Cloud Services Partner of the International Olympic Committee and developed “ET City Brain” to help with city management).
Similar growth trajectories are also observed in earnings - AWS reached USD 3 billion sales 8 years after it was launched and Alibaba Cloud is likely to reach USD 3 billion in its 10th year. AWS has been steadily growing at >40% in the last five years and Alibaba Cloud has been growing at >100% in the last three years.
Similarity #2: Domestic cloud adoption is on the rise
China is in an early stage of cloud adoption at this point, similar to the U.S. in 2010 when the cloud was at its infancy. While Chinese corporations have been underspending in their IT departments over the past years, cloud adoption is likely to largely improve. McKinsey’s survey showed that 84% of CTOs are open to move their on-premise workloads into cloud in the next two years and could use more than one platform, potentially driven by emerging demands and favorable government regulations.
The cost-saving nature of the cloud, the increasing amount of data to be processed, growing online contents and the need for a strong defensive system are likely to drive the demand in elastic computing, data storage, autoscaling, and Anti-DDoS protection over the next decade. Demand for Alibaba’s new cloud features will also be stimulated as companies carry on new technology initiatives, including AI, IoT, and automation.
Other tailwinds include the Chinese government’s recent push to expand cloud use to promote GDP growth and surging of relevant talents. We noted that in 2010, the Obama Administration issued “Cloud First Policy” to make agencies shift some services to the cloud and approved an exchange program to win Silicon Valley’s talents. The policy helped speed up cloud adoption in the U.S. for the following years.
According to Gartner, cloud spending could reach $21 billion in China by 2020, at a CAGR of 40%-45%. We see the cloud business to be counter-cyclical: Even amid the China slowdown, cloud adoption will be less affected as opposed to Alibaba’s core commerce and payments businesses since the public cloud remains cost-saving for businesses.
Similarity #3: Extensive product coverage and ongoing aggressive innovation
AWS’ moat comes from both its global cloud footprint and amount of new offerings it can offer. While Alibaba Cloud faces long road ahead regarding the first part, product-wise, both AWS and Alibaba offer broadly similar cloud services and pricing structures. Alibaba Cloud updates more than one feature a day and has activated 4,610 product features up to now. During 18Q4, Alibaba Cloud launched 678 new products and features, comparable to AWS’ pace in 2016. Alibaba Cloud recently released more complex offerings, including SaaS accelerators and AI chips, a move ahead of AWS and its Chinese competitors. We expect that like AWS, Alibaba can maintain its leadership position domestically, as more value-added vertical solutions and price cuts will create higher customer value propositions relative to peers, resulting in lower customer attrition rates and higher ARPPU (average revenue per paid user).
Roadblocks on its path to becoming AWS
Domestic leadership position could be affected by fast-growing competitors
Alibaba Cloud’s largest domestic competitor, Tencent Cloud, just disclosed its cloud revenue last month for the first time - the cloud segment reported earnings of CNY 9 billion in FY18, with the fourth quarter contributing one-third of the annual revenue. The progress cannot be overlooked, as we noted that while Tencent Cloud was only 1/4 of Alibaba Cloud in 2017 according to IDC, the gap narrowed to 3/4 in 2018. Tencent also announced to restructure its business divisions and established “Cloud and Smart Industries Group”. Restructuring at such firm size showed a big commitment on cloud.
Tencent Cloud started in 2013 and the company did not focus much on cloud until 2016. Though it appeared to be a late mover in Chinese Cloud market and lagged Alibaba for multi-years, Tencent Cloud is currently doing particularly well in some verticals like gaming IaaS and PaaS, serving more than half of the gaming companies.
More challenges and uncertainties amid international expansion
In the international market, while it is hard for Alibaba and US cloud providers to fight on each other’s homelands especially amid US-China trade tensions, it is inevitable for Alibaba Cloud to compete with sized rivals in other regions.
APAC ex-China: Of the 10 international data centers, Alibaba built data centers in 8 regions in APAC to differentiate itself from Google and IBM. In the meantime, Google announced to expand its APAC coverage to 7 cloud regions by 2019, up from only 1 region two years ago. Though Alibaba Cloud beats IBM and Google in a key category IaaS, its overall cloud revenue is no way close to the scale of those two companies. IBM and Google are stronger in PaaS and SaaS, more towards more margin-accretive applications than infrastructure cloud services.
EMEA: Amazon, Google, and Microsoft have wider data center footprints in EMEA, while Alibaba Cloud is still small, less-known and unproven in the regions. Synergy Research did not rank Alibaba among the top five cloud providers in Europe in 2018. Currently, Alibaba Cloud products draw attention to EMEA companies which want to expand to the Chinese market, whereas other enterprises may have more confidence in the US-based vendors, and Alibaba Cloud may face challenges to convince those customers to store their most confidential data with a Chinese tech giant despite the fact that the company has gone through third-party audits. A potential solution might be to form partnerships with local vendors.
Top-line: Revenue experienced triple-digit growths from 2016 to 2018, driven by an increase in both the number of paid users and the average amount of spending per user. Given a million paid Alibaba Cloud users worldwide, the average customer currently spends around USD 2,100 on Alibaba Cloud per year. Aggressive price cut could be a concern (according to McKinsey, cloud competition in China is already so intense that leading players dropped their prices by more than 30% in 2017), but new features and volume increase could offset lower price. In addition, average customer retention rate was 96.7% in FY16 and FY17, according to China Merchant Securities; such a high retention rate should give stronger confidence in recurring revenues from existing clients.
Margins: The company chose to use large portions of its cash flow to fund R&D and CAPEX; the segment still has a negative operating margin. Adjusted EBITA margin has improved to (-4%) from (-5%) a year ago and is at an inflection point to reach breakeven. At this point, the first priority is not profitability but market share and revenue growth.
Public company comparables: We select Adobe, Salesforce, VMware and Workday as public comps. Justification is that though those firms are SaaS-focused, they are entirely dedicated to the cloud area; despite they are in a more mature phase than Alibaba Cloud, higher margins from SaaS relative to infrastructure cloud could offset the slower revenue growth. Therefore, we forecast Alibaba’s Cloud segment to be USD 41 billion by applying an 11x EV/sales (in line with the average of comps) on the consensus estimate FY19 revenue of USD 3.7 billion.