Setback for Alibaba: Cloud Spin-Off Plans Reversed Amid US-China Technological Rivalry

Alibaba, one of China's leading e-commerce and internet computing companies, has experienced a significant setback in its business strategy due to the escalating technological rivalry between the United States and China. The company recently made a surprising decision to reverse its plans to spin off and list its $11 billion cloud business.

The Market Reaction

The Chairman, Joseph Tsai, and CEO, Eddie Wu, who are among the long-time lieutenants of Alibaba's founder, Jack Ma, stated that the increasing restrictions imposed by the United States on chip sales to China have forced the company to rethink its plan to divide its empire into six parts. Additionally, Alibaba has announced the suspension of the listing of its popular grocery business, Freshippo.

The response from Wall Street to Alibaba's reversal was swift and severe, with the company's shares falling 10% in Hong Kong. This drop wiped out over $22 billion in market value, marking the largest decline in over a year.

This decision comes at a challenging time for Alibaba. The company is still recovering from the impact of the Covid-19 pandemic and has recently faced regulatory scrutiny in China's technology industry. It is also working to regain merchants and buyers who have flocked to competitors such as PDD Holdings Inc. and Douyin, as well as corporate clients who have turned to state-backed cloud services.

The restrictions imposed by the Biden administration on the export of certain chips, specifically those designed for artificial intelligence and crucial for data centers and high-performance computing operations that power Alibaba's cloud services, have not been helpful.

"The circumstances have changed," Tsai stated during an analyst conference call. He emphasized that the company now needs to focus on providing cash for investments, as developing a comprehensive business based on highly interconnected and scalable infrastructure requires significant investment.

Alibaba's Strategic Reversal Amidst US-China Tech Tensions

Alibaba is not alone in publicly addressing the challenges posed by US trade restrictions. Tencent Holdings Ltd., another Chinese tech giant, has also faced similar issues. The Biden administration's efforts to prevent the Chinese government from obtaining cutting-edge chips for military applications have begun to impact the country's private sector in unexpected ways.

Analysts suggest that other factors may have influenced Alibaba's change in direction. The company's cloud business has been slowing down and losing market share for years, and it has faced government scrutiny over alleged security violations.

According to Li Chengdong, director of the Beijing-based technology think tank Haitun, the prime time for Alibaba to seek a public listing for its cloud division has already passed. He believes that the strength of the business itself is a problem.

Even before Thursday's announcement, Alibaba's efforts had faced headwinds. The potential IPO of Freshippo in Hong Kong had been postponed due to low confidence in consumer stocks. Former CEO Daniel Zhang resigned just months after accepting the role of leading the cloud division. In late September, Alibaba's logistics arm, Cainiao, filed for an IPO in Hong Kong, but the valuation it will receive remains uncertain.

Nevertheless, the news of Alibaba's reversal surprised almost everyone on Wall Street. The cloud spin-off was seen as a significant corporate move that would have helped reduce the holding company's discount. The planned restructuring had boosted Alibaba's stock price, so a pullback was expected.

The decision was part of Alibaba's most radical corporate review in history, aimed at giving more autonomy to its various businesses, rejuvenating them, and creating more market value. However, this spin-off also threatened to diminish Alibaba's weight and erode its position as one of the leaders in China's digital economy.

Alibaba's executives have now stated that the company will focus on the organic growth of its cloud unit and issue its first annual dividend in history, totaling $2.5 billion. This move is an attempt to appease shareholders who were expecting a significant payout from the unit's debut.

"The market is scratching its head," said Willer Chen, a research analyst at Forsyth Barr Asia. "The first annual dividend seems like compensation to shareholders. However, it may not fully compensate for the blow given the higher value of the cloud unit."

Alibaba announced these decisions alongside solid but unspectacular quarterly earnings. Its sales increased by 8.5% to CNY 224.79 billion ($31 billion), slightly above average expectations, and it reported a profit of CNY 27.7 billion, compared to losses from a year ago.

With Zhang's departure, Tsai and Wu now face the challenge of reviving the cloud division and revitalizing the company as a whole. One of their major bets is on artificial intelligence (AI). Alibaba has launched its own large-scale language model, Tongyi Qianwen, and is also investing in high-flying startups like Zhipu AI and Baichuan. Tsai stated last month that the cloud unit now houses half of China's generative AI companies and serves nearly 80% of the country's tech firms.

It remains unclear how US sanctions will affect these efforts. The cloud division is at the core of Alibaba's AI initiatives and requires powerful chips supplied by Santa Clara-based Nvidia Corp., most of which are now banned from being sold to Chinese companies.

The Ripple Effect of US Trade Restrictions: Alibaba's $22 Billion Market Loss

Aside from the cloud business, Alibaba is also facing challenges in the tepid consumer economy. The company, along with its traditional rival JD.com Inc., experienced a disappointing Singles' Day shopping festival. The two leading Chinese e-commerce players likely achieved only single-digit percentage growth during their annual shopping extravaganza, being outperformed by smaller but more innovative social media platforms like Douyin and Kuaishou Technology. However, both Tencent, which has heavily invested in video, and JD.com reported better-than-expected results on Wednesday.

Alibaba has taken aggressive measures to boost its e-commerce business. Its divisions Taobao and Tmall have focused on content creation to compete with social media platforms and have launched AI tools for merchants. The company has also downsized its workforce by tens of thousands in recent quarters to reduce expenses.