Chinese technology giant Alibaba is shaking up its corporate structure in a series of moves that will allow large pieces of its business to raise capital and potentially even go public.
That may not be a bad idea, when you consider that the conglomerate’s revenue rose a middling 2% in Q1 2023 and its profitability is trending downward (operating income declined 9%) from a year earlier.
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Huge companies like Alibaba often don’t have many ways to make shareholders happy when growth is hard to come by. But one surefire way is to break the business down into smaller pieces and value each part individually. So if a company has a fast-growing business with good margins under the aegis of a slower-growing segment with low margins, it can “unlock” value by letting the market decide how much the more enticing pieces of the company are worth.
Alibaba’s plan to deconstruct itself has a few phases. First, the company in late March divided its operations into six major branches, all of which, apart from its Taobao and Tmall e-commerce businesses, will have the chance to chart their own financial paths. The company is spinning-off its cloud business, while the logistics unit, Cainiao, and its grocery effort, Freshippo, are on track for IPOs.
Of these, the cloud spinoff is worth spending a little time over, so we’re going to examine its Q1 results, contrast its performance with other public cloud companies and make some educated guesses about what it might be worth on its own.
To work!
Cloudy with chance of silver linings
Alibaba’s cloud business, comprising its public cloud (Alibaba Cloud) and its corporate chat platform (DingTalk) products, posted revenue of $2.71 billion in the first quarter of 2023, making up 9% of Alibaba’s total revenue. That’s a lot!
However, revenue actually declined 2% from Q1 2022, which has us intrigued: After all, we’ve seen continued growth at American cloud giants in the same period.
Alibaba shared a few details from the quarter that are worth reading verbatim (emphasis ours):
The year-over-year decrease in revenue of our Cloud segment reflected delays in delivery of hybrid cloud projects given the COVID-19 resurgence in January and normalization of CDN demand compared to the same period last year, as well as the impact from a top customer phasing out using our overseas cloud services for its international business due to non-product related reasons.
In other words, there was an operational issue (delayed project delivery), a macroeconomic matter (content demand coming back to earth) and a sales concern (losing a big account’s overseas custom aka TikTok). That’s a tough set of problems to overcome in a single quarter.
But looking back over the years, we can spot a trend: Cloud revenue at the company rose only 3% in Q4 2022, and just 4% a quarter before then.
Clearly, this is not a fast-growing business in its current form. But we aren’t saying it’s doing poorly — yes, it’s not a growth engine at present, but it’s not a financial dog either: The company reported cloud adjusted EBITDA of $56 million, up about 40% in RMB terms.
Notably, Alibaba is not planning to launch an IPO for this cloud business. Instead, the unit will be listed via a stock dividend distribution to shareholders. That means the cloud group will likely have a similar initial shareholder base as its parent company, of which 18% is held by insiders, per Yahoo Finance.
So, what’s it worth?
That’s the multibillion-dollar question. Alibaba’s major American public cloud competitors are all nested deeply inside their parent companies — we don’t even have hard revenue data for one of them (Microsoft’s Azure). We do know that Amazon’s AWS and Google Cloud are profitable, though.
That makes it nearly impossible to “value” these businesses outside of their parent companies. For example, it’s generally agreed that AWS is a key pillar of Amazon’s growth and profitability, but just how much is it worth? Unless Amazon floats or divests AWS, it’s hard to be certain.
Can we value Alibaba’s cloud group at all? Maybe. We have two services that can serve as shaky comparables for Alibaba’s cloud business:
- DigitalOcean, an American public cloud provider that reported a 30% rise in revenue in the first quarter of 2023, with an adjusted EBITDA margin of 34%.
- 21Vianet, a Chinese cloud provider best known for running Microsoft’s Azure in China. Its revenue rose 7.7% in Q4 2022, with an adjusted EBITDA margin of 26.5%.
For reference, Alibaba’s cloud business reported an adjusted EBITDA margin of around 2% in Q1 2023.
DigitalOcean has a trailing price/sales multiple of 5.4, per YCharts. 21Vianet, in contrast, has a trailing price/sales multiple of 0.42. That lets us infer that the market rewards profitable public cloud businesses with high growth premiums.
Given that Alibaba’s cloud biz is growing slower than both our comparable companies and is less profitable if you compare their adjusted EBITDA margins, should it trade at a price/sales discount to both?
Before we answer that, I want to take a risk: I wonder if 21Vianet is valued at such a massive discount to DigitalOcean due to its dependence on another company (Microsoft)? If we assume that’s true and leave out 21Vianet from our equation, we can value Alibaba’s cloud division as a fraction of DigitalOcean’s own price/sales multiple.
If Alibaba’s cloud business is valued at half of DigitalOcean’s trailing price/sales multiple, annualizing the Chinese cloud business’ Q1 2023 revenue lets us arrive at a price tag of around $29 billion.
That’s a lot of money! Is the cloud business at Alibaba currently valued too high? Who knows. But our estimate pegs it at more than 10% of its parent company’s market cap. And since we know that the cloud business is just 9% of the company’s total revenue, we can infer that it is more valuable on a per-dollar-revenue basis than the rest of the company. As shareholders would say: “There could be value to unlock in the cloud business.”
It is very hard to value a slow-growing business unit, and it’s even harder when we’re forced to use poorly tuned comps. I’m therefore not very confident in our estimated value of Alibaba’s cloud unit.
But the spinoff is expected to be completed in the next 12 months, so we’ll learn more soon enough. Once the business does ply the public market waters by its lonesome, it’ll serve as a useful yardstick to measure other public cloud businesses.
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