Alibaba's Cloud Potential

| About: Alibaba Group (BABA)
This article is now exclusive for PRO subscribers.

Summary

According to forecasts, the Chinese cloud market will reach $20 billion by 2020.

The infrastructure does not yet allow the market to develop in line with its potential.

Chinese information market is risky for foreign investors.

Over the past two years, cloud computing and Internet infrastructure have been demonstrating the best growth rates in the revenue structure of Alibaba Group (NYSE:BABA). Given the huge potential of the cloud market in China and protectionist policies of the Chinese Government in matters of information security, I believe that Alibaba Group cloud-based business is only beginning to accelerate its growth.

Source of data: Alibaba Group

According to Bain & Company, the cloud market in China will reach $20 billion by 2020. For comparison, two years ago the size of this market in China was only $1.5 billion.

Also, according to Bain & Company, though the cloud market in China is behind a similar market in the United States, this gap is constantly decreasing. In this sense, now the cloud market in China corresponds to the cloud market in the United States four years ago. Thus, today's success of companies like Amazon Web Services (NASDAQ:AMZN) and Azure (Microsoft) in the United States indicates favorable prospects for the cloud-based business in China. However, it has some special characteristics.

Source: Bain & Company

The ability of the infrastructure to support the growth of the cloud market is critical. In this context, there is much to be done in China. According to the data as of January 2016, the average Internet speed in China is 3.7 Mbps. For comparison, the average Internet speed in the United States is 12.6 Mbps, and the leader in the global ranking is South Korea with 20.5 Mbps.

China is not one of the world leaders in Internet penetration among the population. Only 49% of China's population has access to the World Wide Web. In the United States, a similar proportion is 87%.

But this is only a temporary difficulty in the way of cloud development market in China. In 2015, the Chinese Government launched a three-year programme costing more than $182 billion, aimed at increasing the speed of Internet traffic in the country. In addition, you should not forget that China has embarked on reorienting its economy for domestic consumption, development of services and high technologies, and this by itself implies expanding the level of penetration of the Internet.

Chinese information market is risky for foreign investors. It is enough to mention the current full ban on Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Facebook (NASDAQ:FB), and Twitter (NYSE:TWTR) in China. However, companies such as Amazon, Microsoft (NASDAQ:MSFT) and IBM (NYSE:IBM) are present in the local cloud market. Usually, they work in partnership with local IT companies. In the meantime, none of the commercial providers in China is immune to blocking in the case of admission of politically incorrect traffic. This means that any geopolitical event may cause a ban of even the most business-oriented provider if the Chinese Government considers that this is necessary for reasons of social stability.

Given the particular nervousness which shows the Chinese Government in relation to the national information security, I personally find it hard to believe that the market share of foreign companies operating in the Chinese cloud market could grow significantly. It is much more convenient and safe for the Chinese companies to use Alibaba Group or Baidu (NASDAQ:BIDU) cloud services because these companies benefit from the trust of the Government. While foreign companies will always be suspected of espionage.

Conclusion

It is difficult to believe, but for various reasons the Chinese cloud market is lagging behind in its development. However, most likely, this situation will change in the future. This, in view of the national specificities of China, creates unique opportunities for the growth of a cloud-based segment of Alibaba Group.

Note: Unless otherwise stated, all charts included are my own.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.