ii view: Alibaba pumping billions into cloud boom

After flagging $28.3 billion of investment in cloud computing, should investors back Alibaba shares?

Massive investment in cloud computing

ii round-up:

Chinese online retailer Alibaba (NYSE:BABA) is to invest 200 billion yuan ($28.3 billion) in its cloud computing division over the next three years, as it battles fellow cloud rivals such as Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT) and Google-owner Alphabet (NASDAQ:GOOGL). 

Investments will be made in servers and upgrading operating systems as the company extends its data centre infrastructure. The new money comes at a time when the corona crisis has injected additional stress into the global economy and underlined the importance of e-commerce. 

Alibaba, founded by 18 people and originally led by Jack Ma, generates revenue mainly by selling advertising and promotional services to third-party merchants that list products on its e-commerce sites. 

With most of China’s office-based personnel working from home in February as Covid-19 spread, the cloud division enjoyed surging demand for its software, including DingTalk, a workplace chat app used by both businesses and schools.

The cloud division accounts for less than one-tenth of Alibaba’s overall sales and has to date remained loss making. It generated revenue of over 10 billion yuan (US$1.54 billion) for the first time back in the last quarter of 2019. 

Aided by the success of Singles Day in November, a Chinese similarity to Black Friday in the US, total Alibaba sales jumped by 38% to $23.2 billion in the last quarter of 2019. 

Having risen by 55% during 2019, Alibaba shares are down by less than 2% during 2020. Amazon and Microsoft shares are up by 28% and 13% respectively year-to-date.  

ii view:

China’s equivalent to US online retailing giant Amazon, Alibaba has made huge progress in its two-decade long history. A new chapter for the company recently commenced as founder Jack Ma passed the leadership reins to Daniel Zhang. 

For investors, exposure to consumers in the world’s second-largest economy is an enticing prospect. A stock market valuation of around $550 billion trails the $1 trillion-plus of Amazon, leaving plenty of room for further potential growth. 

For investors, Alibaba shares do not come cheap, sat on a forward one-year price/earnings ratio of over 200 compared to Amazon’s 80 times. As such, any setbacks could see the share price punished hard. But, with the company looking like a beneficiary of Covid-19 and investment being made into its e-commerce cloud prospects, further long-term growth looks highly likely. 

Positives

• Exposure to the world’s second-biggest economy
• Looking to grow sales outside of China

Negatives

• Cloud computing is loss making
• Major company Tencent Holdings (SEHK:700) also competes in the cloud computing arena

The average rating of stock market analysts:

Strong buy