Alibaba Earnings Preview: Will AI Investments Pay Off?

Introduction

Alibaba [BABA] is a Chinese conglomerate whose business spans cloud services, e-commerce, digital media and entertainment. 

Despite Alibaba’s dominance in China’s cloud services market, in 2023 the provider fell from third to fourth place in the global ranking, overtaken by Alphabet’s [GOOGL] Google, according to a Gartner report released last July. 

Alibaba Cloud’s 7.9% share is dwarfed by those of Amazon [AMZN] and Microsoft [MSFT], at 39% and 23%, respectively. 

In a bid to keep pace with the big tech stocks, Alibaba has been betting on artificial intelligence (AI) to help fuel growth in its struggling cloud business, which has seen revenue plummet since 2022. 

“Any enterprise that is digitalized and relies on digitalization must be investing in AI,” said Alibaba CEO Eddie Wu on the Q2 2024 earnings call in August. 

Ahead of the Q3 earnings release on Wednesday, February 5, this spotlight on BABA stock will look at some of Alibaba’s recent announcements and decisions around AI. It will also unpack what impact AI had on growth in Q2, and highlight some of the tailwinds and headwinds the company is experiencing. 

Superior to DeepSeek?

Amid all the noise surrounding DeepSeek, Alibaba released a new AI model last week. The company claims it outperforms the capabilities of DeepSeek-V3 as well as OpenAI’s ChatGPT-4o and Meta’s [META] Llama-3.1-405B. 

No other details were shared in the WeChat post seen by Reuters. However, the news report noted that Alibaba made the announcement on the first day of the Lunar New Year, when many people in China will have been on holiday. 

The timing of the Alibaba news could be an indicator of the pressure tech companies are now under to keep releasing faster and better AI systems. 

BABA Stock Rallies Amid DeepSeek Sell-Off

While DeepSeek caused the majority of AI and tech stocks to sink in the last week of January, Alibaba’s share price rose 10.88%, hitting its highest level since October on January 30.

BABA stock has gained 16.57% since the start of the year through January 31 and 39.64% in the past 12 months. 

How Does Alibaba’s AI Growth Compare with Competitors’?

Whether Alibaba’s share price can continue pushing higher could depend on how its Q3 results stack up. 

In Q2, which ended September 30, Alibaba’s cloud business unit reported that revenue had crept up 7% year-over-year due to “double-digit public cloud growth, including increasing adoption of AI-related products”. Revenue from AI-related products grew by triple digits for the fifth consecutive quarter, the company added in its press release. Revenue from the cloud unit accounted for approximately 10% of total revenue.

Tencent [TCEHY] reported a slight 2% increase in its Q3 business services revenue, which includes cloud services. However, CEO Ma Huateng said in the earnings release that management is “increasingly seeing tangible benefits of deploying AI across our products and operations”. 

Baidu [BIDU] reported its Q3 non-online marketing revenue rose 12%, fueled by growth in its AI cloud unit and demand for its chatbot Ernie. CEO Robin Li said on the earnings call that Baidu’s search engine could become “a killer app in the age of generative AI."

Here is how Alibaba’s, Tencent’s and Baidu’s fundamentals compare. 

Source: Yahoo Finance

While Alibaba is only expected to report modest revenue growth over the next couple of years, BABA stock could be considered undervalued based on its current price-to-sales ratio. 

BABA stock’s current valuation could also be a reflection of the outlook on Chinese equities amid China’s economic slowdown. 

BABA Stock: The Investment Case

The Bull Case for Alibaba

Beijing has been taking action to stimulate economic growth and to get consumers spending again. This should boost its customer management business, which generates revenue from selling services to merchants and accounted for a little less than a third of total revenue in Q2. 

In a bid to boost these service fees, Alibaba implemented a major change to how it charges its merchants. As of September, sellers on Taobao and Tmall pay a 0.6% software service fee on gross merchandise volume, as opposed to a fixed annual fee. 

The Bear Case for Alibaba 

The race to AI supremacy has forced Alibaba, along with Tencent, to slash the pricing of large language models (LLMs).

On December 31, the cloud unit announced the cost of its advanced model, Qwen-vl-max, would be cut by up to 85%, following ByteDance’s decision to launch a competing LLM earlier in the month, as first reported by the Alibaba-owned South China Morning Post. It marked the third time prices had been reduced in the calendar year.

While this may not have an impact on Alibaba’s cloud revenue, it raises questions about how crowded the AI market is becoming, what it will take for companies to remain competitive, and whether further price cuts would be sustainable. 

Conclusion

Alibaba’s cloud unit may only account for a tenth of its total revenue, but AI is central to the company’s long-term cloud strategy. If the insatiable appetite for LLMs starts to wane, however, then its investments in AI could end up proving costly. 

Q3 results on Wednesday will show whether these investments are continuing to pay off.