Alibaba (BABA 1.44%) is the largest e-commerce, digital advertising, and cloud platform company in China. Its sprawling ecosystem also includes streaming media platforms, a film studio, a mobile browser, smart speakers, and various other businesses.

Alibaba's stock has more than tripled since its IPO in 2014, and it's considered by many to be one of the most stable tech plays in China. It also remains cheap relative to its growth: Analysts expect its revenue and earnings to rise 34% and 29%, respectively, this year, but its stock trades at just 25 times forward earnings.

Alibaba will likely weather the near-term headwinds like the U.S.-China trade war and the coronavirus outbreak, but investors should note that it still faces three major challenges that could curb its long-term growth. These challenges are:

Alibaba's corporate campus in Hangzhou.

Image source: Alibaba.

1. A growing dependence on lower-margin businesses

Alibaba's core commerce business grew 40% annually last quarter and accounted for 85% of its top line. Most of that growth came from its Taobao and Tmall marketplaces, which generate high-margin revenue by charging commissions and listing fees for higher search rankings. That higher-margin business model makes the core commerce business Alibaba's only profitable segment, and those profits subsidize the growth of its unprofitable cloud, digital media, and innovation initiatives businesses.

But over the past year, Alibaba relied more heavily on the growth of its brick-and-mortar stores, direct sales from its cross-border marketplaces, and higher investments in the third-party logistics platform Cainiao to pad its core commerce unit's growth.

If we exclude all those lower-margin businesses, Alibaba's core commerce revenue would only have risen 28% instead of 40% last quarter. Its rising dependence on lower-margin revenue notably reduced the core commerce unit's operating margin by 180 basis points annually to 31.7% last quarter, and that pressure could intensify in the coming quarters.

2. Its margin-crushing war against Pinduoduo

Alibaba's escalating war against Pinduoduo (PDD 2.28%), the discount rival that encourages shoppers to make bulk purchases, will likely exacerbate that pressure.

Tiny parcels on a laptop keyboard.

Image source: Getty Images.

Pinduoduo surpassed (JD -1.68%) as China's second-largest e-commerce platform in terms of active shoppers (but not revenue) last year, and it grew its active buyers 85% annually to 429.6 million. Alibaba remains in the lead with 693 million active buyers, but it's growing at a much slower rate.

Pinduoduo is particularly dangerous because its bulk purchase model drives down prices. It also convinces big brands to sell their products at a loss by subsidizing the difference out of its own pocket. Alibaba is desperately trying to hold Pinduoduo at bay with low-margin strategies like its Juhuasuan discount marketplace and its Taoxiaopu dropshipping platform, which encourages customers to sell products for other merchants without maintaining physical inventories.

Alibaba is also allegedly locking merchants into exclusive deals by removing stores and search results for merchants that also peddle their products on Pinduoduo. That strategy, which Pinduoduo and merchants openly protested, could spark antitrust probes in the future.

3. Tencent's new priorities

In late 2018, Tencent (TCEHY 1.92%) restructured its businesses to prioritize the growth of its cloud and fintech businesses, which directly compete against Alibaba Cloud and its affiliate AliPay. Tencent's fintech and business services unit, which houses those two businesses, posted 36% annual revenue growth last quarter.

Within that total, Tencent's cloud revenue surged 80% to 4.7 billion yuan ($670 million). By comparison, Alibaba's cloud revenue grew 64% to 9.3 billion yuan ($1.3 billion) last quarter. Alibaba still has a much larger cloud business than Tencent, but its growth is gradually decelerating and it isn't generating a profit.

Tencent's aggressive expansion claimed 15% of China's cloud platform market last year, according to Canalys, putting it in second place behind Alibaba's 47% share. Alibaba will likely need to spend more heavily to hold Tencent at bay, which would further erode its total operating margins.

Tencent's WeChat Pay also maintains a near-duopoly in China's online payments market with AliPay, which is tethered to Alibaba's other commerce platforms. If WeChat Pay pulls ahead of AliPay, Tencent could weaken the links between brick-and-mortar retailers and Alibaba's commerce and cloud ecosystems.

The key takeaways

Alibaba remains the 800-pound gorilla across multiple markets, but it isn't invincible. Its strengths clearly outweighed its weaknesses in recent quarters, but investors shouldn't be surprised if its lower-margin strategies, aggressive moves against Pinduoduo, and its escalating war against Tencent throttle its earnings growth in the future.