Alibaba and Tencent’s darkening clouds

Just over a year ago, with Alibaba facing an antitrust investigation and founder Jack Ma under political pressure, finance chief Maggie Wu was quick to talk up the company’s rapidly expanding and uncontroversial cloud business to investors.

“China is going to be the largest economy in 10 years’ time, enterprises and millions of businesses will migrate to cloud,” she said at a Goldman Sachs conference last February, according to notes provided to the Financial Times.

But Wu’s suggestions that Ali Cloud’s 50 per cent year-on-year growth rate was sustainable proved overly optimistic. Today, growth has stagnated at its cloud computing division, with sales up just 12 per cent in the first quarter of 2022 from a year earlier. Top rival Tencent reported its cloud arm shrank in the same period.

The faltering cloud businesses reveal how China’s tech giants are struggling to regain their footing as they battle a regulatory onslaught from Beijing and a slowing economy caused in part by a draconian coronavirus regime that has paused commercial activity in much of the country.

The lacklustre growth has defied expectations that cloud computing could transform the Chinese tech groups in the way that Amazon Web Services revamped the US ecommerce giant and Azure bolstered Microsoft.

Competition from politically favoured vendors such as national champion Huawei and state-backed telecoms companies including Tianyi Cloud, run by China Telecom, and Tsinghua Unigroup is adding to the pressure.

Unlike its Silicon Valley peers, growth at Alibaba’s cloud unit has slowed considerably over the past 12 months while profits remain nascent. Tencent, meanwhile, has shifted from maximising growth to chasing profitability.

One piece of the slowdown puzzle is the structure of China’s cloud market. The country’s public cloud represents about 60 per cent of the market, with Alibaba and Tencent the two leading players.

In the public cloud, multiple companies share a vendor’s platform. This part of the market is so dominant in the US that it is generally known as “the cloud”, with Amazon, Microsoft and Google dominating the sector.

However, in China, 40 per cent of the market is devoted to the private cloud, where companies use dedicated and often highly customised computing resources, according to the China Academy of Information and Communications Technology, a government-run think-tank. Customers in this part of the market include large state-owned enterprises and governments. The leading vendors are Huawei, state-owned providers and also Alibaba.

In the public cloud, internet industry customers represent about half of all end users, which has left Alibaba and Tencent’s cloud arms vulnerable to China’s tech crackdown. Alibaba cited waning usage from edtech companies, which had their business model outlawed by Beijing, and online entertainment firms, which have faced tougher rules.

The regulatory shift has also spurred venture capitalists to ditch the consumer internet space. “Lots of small internet companies with less than 100 people have closed this year,” said a person close to Alibaba’s cloud division. “They are the main cloud users, if they’re gone, we’re hurting.”

Yi Zhang, an expert at Canalys, said growing competition and slowing demand in the public cloud market meant tougher times for cloud vendors. “The overall market is getting saturated,” she said.

In the 12 months to March 31, Ali Cloud’s growth has slipped, with sales up just 23 per cent on the year to Rmb75bn ($11bn) and an operating loss of Rmb5bn. In comparison, Amazon grew its cloud revenue 38 per cent in the same period, contributing $21bn of operating income on $67bn in sales.

“Cloud is Alibaba’s second most important business after ecommerce, so the slowdown is concerning,” said Shawn Yang, managing director at Blue Lotus Capital Advisors. “Alibaba has been saying it was because of losing a key customer, which was ByteDance’s TikTok, but clearly there are other reasons too,” he said.

Aside from losing TikTok, Alibaba’s chief executive Daniel Zhang last month also blamed the Covid-19 outbreak for delaying projects, the faltering economy and declining demand from internet companies, while asserting the growth slowdown was only temporary. “Digitisation of other industries is just starting and we see plenty of opportunities,” he said.

But analysts said the structural issues and growing competition would remain at least near-term challenges for Alibaba and Tencent.

“Only small companies want to use the public cloud,” said Evan Zeng at Gartner. Large enterprises “don’t trust the public cloud providers . . . they want control over security and the entire environment”.

Boris Van, China software senior analyst at Bernstein, added that Beijing’s rollout of a slew of cyber security and data privacy policies last year convinced more companies to opt for private cloud computing. “They want better control over their data environments,” he said.

Tencent, meanwhile, said it was turning away from lossmaking services such as offering discounted cloud infrastructure and highly customised projects, which caused its sales to fall in the first quarter.

James Mitchell, Tencent’s chief strategy officer, said many cloud vendors provided “cost-heavy solutions” akin to acting as an IT consultancy. “While that is achievable in an environment of kind of infinite capital . . . it’s not sustainable,” he told investors last month.

With rising competition from telecoms and Huawei, Tencent and Alibaba are shifting away from low value-add private cloud work, said Robin Zhu, China internet analyst at Bernstein. “They are focusing on higher-margin cloud services — we expect slower growth in the next few quarters.”

Recent public procurement contracts reviewed by the FT show dozens of vendors competing for government contracts. Several local governments, such as the city of Changsha, awarded renewals to Huawei in no-bid competitions, but the tenders showed fewer automatic deals for Alibaba or Tencent.

An official in Alibaba’s home province of Zhejiang said the company had done well in winning government contracts before 2020, when founder Ma crossed a political red line with a speech in Shanghai criticising regulation.

“That era has gone as Alibaba fell out of favour with President Xi [Jinping],” said the official. “These days we are leaning towards state-backed cloud services like Tianyi as they are considered more politically reliable. That will be the trend in the coming years.”

Additional reporting by Nian Liu in Beijing