Competition in the cloud appears to be heating up. China-based tech giant Alibaba Group (BABA 6.38%) has released an artificial intelligence (AI) update in a likely attempt to challenge cloud leaders Amazon and Microsoft.
Yet the stock remains lackluster, selling for little more than its initial public offering (IPO) price nine years ago. Plus, rising political risk surrounding this company is causing some investors to avoid the stock. Here's why they're right to do so for now.
Alibaba Cloud and its financials
By any measure, Alibaba Cloud is a force in the cloud industry. As measured by market share, it is the fourth-largest cloud provider.
Moreover, the upgraded artificial intelligence (AI) model capitalizes on improved generative AI capabilities. Hence, it can understand complicated instructions and handle tasks such as copywriting, reasoning, and memorizing, according to an Alibaba press release.
Meanwhile, Alibaba announced earlier this year that it plans to split into six units, with Alibaba Cloud becoming a separate company. However, former CEO Daniel Zhang has become the center of much uncertainty. He stepped down as CEO in June to focus on the cloud unit, only to resign as head of the cloud unit in September.
Such actions by company leadership naturally lead to questions about the direction of this particular part of Alibaba's business.
Why Alibaba Cloud may not help Alibaba
Still, Alibaba's expansion continues amid the uncertainty. In the second quarter of 2023 alone, it drove 234 billion yuan ($32 billion) in revenue, a 14% yearly increase. Unfortunately, even with improving generative AI capabilities, Alibaba Cloud did not contribute significantly to this increase. The cloud unit reported $25 billion yuan ($3.5 billion) in revenue, rising 4% over the same period.
Fortune Business Insights forecasts a 20% compound annual growth rate (CAGR) for the cloud through 2030. Hence, the slump should be temporary, but this growth rate indicates Alibaba is not immune from the cloud slowdown affecting peers like Amazon.
Also, net income reached 33 billion yuan ($4.6 billion), climbing 63% versus year-ago levels. A more modest increase in operating expenses allowed for more rapid profit growth. But despite this growth, Alibaba sells for a much lower earnings multiple than its peers.
BABA PE Ratio data by YCharts
Macro challenges
Also, investors should remember that they are not buying stock in Alibaba but rather American depositary shares (ADS), which amount to bank-issued certificates representing shares of Alibaba. While that is not a danger by itself, the specter of deteriorating U.S.-China relations could call into question the future of the ADS.
Furthermore, even without geopolitical concerns, the company's breakup into six units leads to questions about the company's future that go beyond Zhang's resignation. Each of the six companies will raise capital on their own and presumably launch IPOs, but that process could bring more uncertainties as each company goes through the filing process.
That may also explain why Alibaba's stock has traded in a range since the announcement. Despite the breakup's potential to unlock value, investors may hesitate to buy because of the numerous questions about its future and macro risks.
Avoid Alibaba
Understandably, investors have taken a heightened interest in AI stocks amid the interest in generative AI. The fact that Alibaba wants to go toe to toe with Amazon and Microsoft in this area could bode well for the company from a competitive standpoint.
However, at the moment, the cloud industry is in a slump. While the industry should turn around, Alibaba is fraught with numerous uncertainties. Moreover, even if investors can capitalize on the planned breakup, deteriorating U.S.-China relations could make the stock uninvestable.
Investors love to find bargains, and admittedly, a bargain tied to generative AI looks enticing in today's market environment. Still, the uncertainties surrounding Alibaba probably mean investors should steer clear of this specific AI stock.
