Alibaba (NYSE:BABA) is often called the "Amazon (NASDAQ:AMZN) of China" because it's the country's largest e-commerce and cloud infrastructure company. But that generalization glosses over two key differences between the tech giants.

First, Alibaba's online marketplaces don't take on inventories, but Amazon does. Second, Alibaba generates all of its profits from its core commerce business, and its cloud business is unprofitable. Amazon's cloud platform, Amazon Web Services (AWS), is consistently more profitable than its online marketplaces.

Therefore, Alibaba subsidizes the growth of its cloud platform with its e-commerce profits, while Amazon supports its e-commerce business with its cloud platform's profits.

A network of cloud computing connections.

Image source: Getty Images.

Alibaba's approach is arguably less stable, because its core commerce margins have been shrinking as it relies more on lower-margin businesses -- including brick-and-mortar stores, cross-border e-commerce, and Cainiao logistics -- to boost its total revenue. Therefore, many investors are likely wondering if Alibaba's cloud business will ever turn profitable and reduce some of the pressure on its core commerce business.

A closer look at Alibaba Cloud

Alibaba Cloud was launched 11 years ago. It controlled 40.1% of China's cloud infrastructure market in the second quarter of 2020, according to Canalys, while its top rivals Huawei and Tencent (OTC:TCEHY) held 15.5% and 15.1% shares, respectively.

Alibaba Cloud also controlled 5% of the global cloud platform market in the second quarter, according to Canalys, putting it in fourth place behind AWS (31%), Microsoft's (NASDAQ:MSFT) Azure (20%), and Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google Cloud (6%).

Alibaba Cloud currently operates data centers in 67 availability zones across 22 regions worldwide. It mainly offers its services on a pay-as-you-go basis, and it provides companies with various integrations with its online marketplaces and Ant Group's Alipay fintech services.

How much money is Alibaba Cloud making?

Alibaba Cloud is Alibaba's second-largest business. It generated 8% of its revenue last year, but it's never generated an annual profit.

Its revenue rose 54% in USD terms in fiscal 2020, but that marked a slowdown from its 72% growth in 2019 and 121% growth in 2018. Meanwhile, its GAAP operating and adjusted EBITA losses widened:

Fiscal Year

2018

2019

2020

Revenue

$2.14 billion

$3.68 billion

$5.65 billion

Operating Income

($492 million)

($821 million)

($991 million)

Adjusted EBITA

($127 million)

($172 million)

($199 million)

Source: Alibaba.

However, Alibaba Cloud's adjusted EBITA margin gradually improved as economies of scale kicked in:

Fiscal Year

2018

2019

2020

Adjusted EBITA Margin

(6%)

(5%)

(4%)

Source: Alibaba.

In the first half of 2020, Alibaba Cloud's revenue rose 68% year over year to $4.01 billion as the COVID-19 crisis caused companies to ramp up their spending on cloud services to support their online platforms. It attributed that growth to robust demand from the internet, finance, and retail sectors, as well its growing penetration rate in China and ARPU (average revenue per user).

Alibaba Cloud's operating loss widened year over year from $481 million to $820 million during the first half of the year, but its adjusted EBITA loss narrowed from $123 million to $73 million.

Profitable by the end of the year?

During its investor day presentation in late September, Alibaba claimed its cloud business would turn profitable by the end of fiscal 2021. CEO Daniel Zhang reiterated that view during Alibaba's last conference call in early November.

CFO Maggie Wu also said Alibaba Cloud would "definitely" achieve "profitability in the following two quarters," and it could eventually match the margins of "other peer companies" over the long term. Wu was presumably referring to Amazon, as most of Alibaba Cloud's other rivals are either unprofitable or don't disclose their cloud profits.

However, Alibaba probably only expects Alibaba Cloud to turn profitable on an adjusted EBITA basis -- which excludes stock-based compensation, taxes, interest, and other variable expenses -- instead of a GAAP basis. AWS, by comparison, is firmly profitable by GAAP measures.

Therefore, the underlying profitability of Alibaba Cloud might be improving, but investors shouldn't cheer until the segment's GAAP operating losses actually start to narrow.

The key takeaways

Alibaba's core commerce margins will likely keep declining, so it's facing increasing pressure to turn Alibaba Cloud into a profitable business. Alibaba seems to be on the right track, but competition from Tencent and Huawei -- along with new antitrust rules in China -- could still generate unpredictable headwinds.