This is the last of my Cloud IaaS series. You should have plenty of analysis to last a few earnings seasons :) I hope it comes in handy as this will be one of the top revenue segments across tech growth stocks in the near-term. You can reference the series in the links at the end this article.
Alibaba Cloud reported 84% year-over-year growth in Q4 2018, primarily driven by enterprise customers totaling $962 million. Across all IaaS cloud providers in China, Alibaba claimed 43% of market share in H1 2018. Alibaba Cloud contributes only 7 percent of overall revenue, which is why there is opportunity for growth. This is what the current YoY trajectory looks like when modeled.
The law of large numbers could slow the trajectory depicted on the chart, although China’s late entry to the cloud IaaS market is likely to do the opposite and accelerate (or at least sustain) the YoY growth in the near-term. Today, AWS reports 50% growth YoY more than a decade after it launched. Microsoft’s Azure reported 300% growth between 2015-2016 and 90-100% growth for the following years.
Globally, Alibaba has quietly become the number 4 cloud services provider worldwide, behind Amazon, Microsoft and Google when Synergy Research Group placed Alibaba ahead of IBM. Across Asia Pacific, Alibaba is the number 2 cloud services provider.
My prediction is that Wall Street will warm up to Alibaba Cloud when the positioning is third-place globally or first place in Asia-Pacific. Cloud IaaS has a history of running under radar as it’s a business-to-business revenue segment with little brand name appeal. For instance many investors mistakenly believe Amazon is mainly an e-commerce company. Amazon's AWS did not have any competitors for 7 years, and a few competitors have let Wall Street down, such as Oracle, with stock prices that have traded sideways for many years. These are a few reasons Alibaba Cloud is not more pronounced as a long-term investment holding while sitting in 4thplace.
Alibaba Cloud was launched in 2009, however, the company did not take the IaaS revenue segment seriously until 2015, when Alibaba made its first investment of $1 billion. As stated in previous analysis, China has been late to adopt IaaS cloud, and this likely contributed to Alibaba’s delay. When adjusting Alibaba Cloud to 2015, we see it took 3 years to reach $1 billion run-rate (2015-2018) while it took Amazon 6 years to reach a $1 billion run-rate on AWS (2006-2012).
Capex for Cloud IaaS
For the most recent quarter, adjusted EBITDA margin for Alibaba Cloud was negative ten percent compared to negative four percent the same quarter last year. According to the company, infrastructure and capacity investments triggered the quarterly loss.
However, even with an annual increase in capex from 2.61B in 2017 to 4.5B in 2018 across all segments, Alibaba’s free cash flow grew from $9.33B to $14.38B, respectively. Therefore, like Amazon, the e-commerce business is able to carry the capex requirements. With that said, investors should be aware that building modern cloud computing services requires billions every quarter. For example, Google spent $5.6 billion in accrued capex during Q3 2018 and Microsoft spent $4.3 billion on capex during the same quarter for “ongoing investment to meet demand for our cloud services,” as pointed out by Amy Hood, Microsoft’s CFO.
The current stock price reflects the renewed enthusiasm in China and tech stocks as Alibaba is up 35% from its December low, at time of writing. There will be opportunities for an attractive entry this year as Alibaba Cloud will not command AWS-level and Azure-level percentages of revenue until H1 2020/H2 2020 and onward. Keep in mind, once AWS and Azure reached $5 billion in revenue, stock prices were around $300 and $70, respectively so entering Alibaba before the Cloud revenue reaches $2-$4 billion is important. While IaaS did not account for all of the increase in revenue (obviously) from the $300 and $70 stock price mark for AMZN and MSFT, I want to emphasize that cloud IaaS is Amazon’s top growth driver still today and Microsoft’s fastest growth driver for many years is Cloud IaaS. The capex costs will affect free cash flow at times, however, this is not a concern long-term as typical cloud profit margins are around 58 percent and typical operating margins are at 22 to 32 percent.
China is a sleeping giant in artificial intelligence and machine learning. While it’s common knowledge the country is waking up to become a technology superpower, China’s cloud IaaS market will reach an inflection point in the next 1-2 years. The 1.3 billion population will fuel cloud infrastructure consumption and rival the United States as cloud IaaS becomes the virtual infrastructure for global economies. Once Alibaba Cloud reaches $5 billion, the stock is likely to find a renewed, stable trajectory from this secular and booming revenue segment.
I wanted to leave you with a fun, little blurb from Amazon’s earnings in 2011 on AWS when it was at $1 billion in revenue (it’s now at $25 billion in annual revenue in 2018). Alibaba Cloud is at the $1 billion barrier right now.
“The speculation that Amazon's cloud is breaking the $1 billion barrier in the very near future comes as the cloud giant prepares to announce its 2011 second quarter earnings Tuesday.
"While still very small for Amazon (likely about $750 million revenue run rate), given the size of the market opportunity and Amazon's strong competitive positioning, we believe that this could soon be a $1 billion revenue segment," Citigroup Internet analyst Mark Mahaney said in a note to investors last week.
And Mahaney isn't alone in his lofty Amazon cloud expectations. In fact, his estimate could be seen as conservative. JPMorgan Chase's Dough Anmuth told Reuters that he expects Amazon's AWS to generate a whopping $2.6 in revenue come 2015.”
More analysis on Cloud Infrastructure-as-a-Service on FATRADER