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Alibaba's Digital Media and Entertainment Unit Is Still a Money Pit

By Leo Sun - May 16, 2019 at 9:00PM

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Latest earnings report hints that the tech giant should spin off its fragmented and unprofitable digital-media platforms.

Alibaba ( BABA -3.95% ) posted impressive fourth-quarter numbers this week that easily beat analysts' expectations. Its revenue rose 51% annually to 93.5 billion RMB ($13.9 billion), topping estimates by $600 million. Its non-GAAP net income rose 42% to 20.1 billion RMB ($3 billion), or $1.28 per share -- which crushed estimates by $0.33.

Alibaba's full-year revenue rose 51% as reported, or 39% after excluding the consolidation of its acquired businesses. For fiscal 2020, it expects its revenue to rise 33%. Those growth rates look solid, and they should allay some fears about the slowing Chinese economy.

However, a closer look at Alibaba's four main businesses -- core commerce, cloud computing, digital media and entertainment, and innovation initiatives -- reveals that only its core commerce segment, which generated 84% of its fourth-quarter sales, was profitable.

Alibaba's corporate campus in Hangzhou, China

Image source: Alibaba.

Alibaba's biggest money pit was its digital media and entertainment unit -- which includes its video streaming platform Youku Tudou, its streaming music platform Alibaba Music, streaming video services for its e-commerce sites (like Tmall TV), its Alibaba Pictures movie division, and its UC web browsers. That business's revenue rose 23% to 24.1 billion RMB ($3.6 billion) in fiscal 2019. But it posted an operating loss of 20 billion RMB ($3 billion), compared to a loss of 14.1 billion RMB in 2018.

Should Alibaba consider spinning off this money-losing unit to improve its profitability?

Why Alibaba's Digital Media and Entertainment unit exists

Alibaba initially established the digital media and entertainment unit to expand its ecosystem against China's two other tech giants, Baidu ( BIDU -0.67% ) and Tencent ( TCEHY 1.33% ).

Baidu's iQiyi ( IQ -9.46% ) and Tencent Video are the two most popular video streaming platforms in China. Tencent Music ( TME -7.37% ) is the country's top music streaming platform, and Tencent Pictures financed blockbuster movies like Wonder Woman, Venom, and Bumblebee.

Tencent's QQ Browser is also a popular alternative web browser in China, while its top messaging app, WeChat, locks in mobile users with Mini Programs for games, purchases, deliveries, and other services. In other words, Alibaba launched all of these side projects because it wanted to counter Baidu and Tencent's expansion plans.

Alibaba digital expansion can't keep up

Unfortunately, Alibaba's digital expansion trailed far behind Baidu and Tencent's. Youku Tudou still ranks third in the streaming video market behind Tencent Video and iQiyi, although it grew its average daily subscribers by 50% in 2019.

Alibaba Music is also a distant underdog in the streaming music market. Tencent Music controls about 78% of that market, while NetEase Cloud Music ranks second with a 16% share. Everyone else, including Alibaba, is fighting over the remaining 6%.

A computer user watches a streaming video on a laptop

Image source: Getty Images.

Alibaba had better luck in web browsers, thanks to its takeover of UCWeb in 2014. The UC Browser controls 11% of the Chinese web browser market today, according to Statcounter, which puts it in third place behind Chrome (52%) and Safari (12%). Tencent's QQ Browser ranks fourth with a 9% share.

Alibaba Pictures financed some major recent film releases, including two Mission Impossible films and Star Trek Beyond. But it also funded massive flops like Asura, a Chinese film that cost $113 million to produce but grossed just $7 million. Alibaba recently increased its stake in the unit to 51% and more closely aligned the business with its other digital-media platforms -- which indicates that it could spend even more money to produce original content for Youku Tudou.

Why doesn't Alibaba spin off the whole unit?

Spinning off the entire digital media and entertainment unit would significantly boost Alibaba's bottom-line growth and generate fresh cash for its core businesses. That's why Baidu and Tencent spun off iQiyi and Tencent Music, respectively, last year.

However, Alibaba insists that the unit is a "key piece" of its Live@Alibaba strategy, which enhances its core commerce business with video features (which lets merchants sell their products through live broadcasts) while diversifying its top line away from its core marketplaces.

Alibaba also likely believes that the unit's profitability will gradually improve as it converts more of its free Youku Tudou and Alibaba Music users to paid subscribers. But that could be a tough uphill battle since iQiyi, Tencent Video, and Tencent Music already dominate those markets.

Alibaba probably won't spin off this business anytime soon, but investors should realize that it's a dead weight on the company's bottom line. It's growing its revenue at less than half the pace of its core commerce business, yet it's losing more money than any of its other businesses -- which makes it the weakest link of the tech giant's otherwise solid operations chain.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Alibaba Group Holding Limited Stock Quote
Alibaba Group Holding Limited
$122.49 (-3.95%) $-5.04
Baidu, Inc. Stock Quote
Baidu, Inc.
$148.83 (-0.67%) $-1.01
Tencent Holdings Limited Stock Quote
Tencent Holdings Limited
$59.23 (1.33%) $0.78
iQIYI, Inc. Stock Quote
iQIYI, Inc.
$5.65 (-9.46%) $0.59
Tencent Music Entertainment Group Stock Quote
Tencent Music Entertainment Group
$6.66 (-7.37%) $0.53

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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