IBM's China Foray Derailed

| About: Alibaba Group (BABA)

Summary

IBM and Chinese property and entertainment conglomerate Dalian Wanda announced a partnership in March last year to jointly serve the cloud-computing market in China.

I explained in October that Dalian Wanda had its hands full with its "myriad businesses" and might not be able to commit to the deal.

The concern has apparently materialized with the Chinese media reporting Wanda's decision to withdraw from the cloud business.

In this article, I sought to highlight the danger of fully pricing-in the benefits of a firm entering a new market, no matter how great the opportunities are.

The developments validated my postulation that the IBM-Wanda alliance was of minor threat to Alibaba Cloud.

In October last year, I wrote about the ambitious cloud-computing moves by Alibaba (BABA). In a span of a few days in October, Alibaba announced a flurry of partnerships with Red Hat (RHT), Xilinx (XLNX), and STMicroelectronics (STM). In that same month, Simon Hu, senior vice-president of Alibaba Group and president of Alibaba Cloud, declared that the then fourth-placed Alibaba Cloud (a.k.a. Aliyun) was "on track" to surpassing Amazon AWS (AMZN) to become the top provider of cloud services in the world. Later in my article, in the section on potential obstacles to Alibaba Cloud’s ambition, I brought up the collaboration between Dalian Wanda (OTC:DLWNY) (OTC:DWNDF) and IBM (IBM).

Quote from the October article (emphasis added):

"Dalian Wanda's Wanda Cloud Company might have found itself a solid name as a partner. However, IBM's cloud division holds just a small percentage of the entire market. It is also uncertain how much commitment Dalian Wanda has on its cloud venture given the myriad businesses the company dabbles in at any one point in time. ... The heightened scrutiny would mean that the management's attention would now be switched back to focusing on its core businesses like property development and investment. Its cloud venture would thus be relegated to playing second fiddle, reducing the immediate threat to Alibaba."

Alibaba Cloud Logo

When IBM embarked on its cloud venture in China in March last year, the company did so with much fanfare. There was substantial media coverage touting the vast opportunities for the company given the fast-growing China market. Reuters reported it, Bloomberg has an article, and prominent Asian finance publication Nikkei Asian Review also opined on the merits. Fast forward a few months later, the rosy outlook is dashed. Cracks in the partnership with Dalian Wanda developed. While Bloomberg was very prompt in its reporting of the IBM-Dalian Wanda alliance, it has thus far been silent on the deteriorating ties.

Nevertheless, several Chinese media have already provided some insights into how the partnership turned sour. Caixin described the IBM-Wanda deal to be in "serious jeopardy". Despite taking a year in negotiation to finalize the partnership, the deal seemed to have fallen apart in just a few months. Wanda Internet Technology Group, the division of the property and entertainment conglomerate liaising with IBM, is reportedly planning further layoffs despite already having several job cuts last year. In a sign that the partnership has not been amicable for some time, Caixin wrote that "Wanda’s move to slash the sales team of the cloud department late last year was taken without discussing with IBM beforehand".

IBM has many moving parts and a setback in one of its divisions at a particular locale (albeit a large and fast-growing one) would not sink the company. While I had previously written an article on why Warren Buffett, through his Berkshire Hathaway (BRK.A) (BRK.B), was likely to sell part or all of his holdings in IBM, I was not suggesting readers to short the Big Blue. Rather, I meant to caution on the optimism on the stock then. The chart below shows the price trend since the article was published. While the stock remains positive, albeit just slightly, the performance pales that of the S&P 500 (SPY) which rose 8.2 percent in the same period.

Chart IBM data by YCharts

Back to the motivation for this article. I aim to highlight that a company’s entry into a promising market is only the beginning. When pricing in the positives in a development, it’s important to note that the road to enjoying the fruits of labor can be long and arduous. A better gauge of the success or failure can be derived by understanding the partner the company has chosen to work with. In the case of IBM’s China foray, it has chosen a distracted partner whose core business interest is in the entertainment and property (e.g., shopping malls, movie theaters, amusement parks) sectors.

Dalian Wanda famously challenged Disney (NYSE:DIS) and declared its plans to rapidly expand its amusement park footprints. The company is also under the cosh for its aggressive deal-making which invited deep scrutiny by the Chinese government. With Dalian Wanda fighting on multiple fronts, it was not difficult to see why it was unable to commit to fulfilling its part of the deal with IBM.

Conclusion

All is not lost for IBM, as it can still seek out other domestic partners. Perhaps, after understanding what went wrong, it can emerge stronger from this unfortunate turn in events. Regardless, in the meantime, the remaining cloud players can grab the opportunity to convert IBM's cloud customers to their own. This certainly bodes well for Alibaba Cloud as well.

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Disclosure: I am/we are long BABA.

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.

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