Alibaba's $56 Billion AI Bet Is Getting Expensive

One of China's largest e-commerce and technology companies, Alibaba Group (BABA) reported weaker-than-expected quarterly results on Thursday, August 20, and U.S.-listed shares fell nearly 4% in early trading on the news. Net income fell 75% to $1.6 billion, or RMB 10.54 billion, for the period ended June 30, down from RMB 43.12 billion in the same quarter last year and missing the Street's consensus estimate of roughly RMB 22.6 billion.

Why Profit Collapsed

Alibaba's capital expenditures soared 75% year over year to RMB 67.68 billion, with nearly all of the increase going to build out AI-related computing capacity, such as data centers and the chips to power them. The company is spending so aggressively on AI infrastructure that free cash flow, which was already an outflow of RMB 18.8 billion in the prior-year quarter, more than doubled to an outflow of RMB 44.7 billion this quarter. To be sure, Alibaba's revenue rose 9% year over year to RMB 268.95 billion in the quarter, roughly in line with analysts' estimates. It is still a profitable, growing company. It is just choosing to plow far more into AI infrastructure than that profit alone can cover, in order to bet big on one initiative: Alibaba Cloud.

The Bet Is Already Paying Off, Just Not on the Bottom Line

Alibaba Cloud has been growing at an unprecedented pace, with cloud and compute revenue up 45% year over year in the latest quarter, to RMB 48.44 billion, representing the fastest growth the segment has posted in 22 quarters. Specifically, AI-related product revenue, a key metric to watch, continued to power ahead in triple-digit fashion for the 12th straight quarter, reaching RMB 12.38 billion. Importantly, even as Alibaba burns through a small fortune on AI and cloud infrastructure, its cloud business is actually becoming more profitable rather than less. The segment's adjusted margin has risen to around 11.6% in the latest quarter, up from roughly 7% in the year-ago period. CEO Eddie Wu added on the earnings call that the AI computing investments Alibaba is making are now expected to break even within two to three years, faster than the company's original timeline.

Alibaba Is Only Halfway Done

Here's an important point to note: Alibaba is only halfway through this enormous spending program. The company had previously committed to a three-year, RMB 380 billion, around $56 billion, AI infrastructure plan. In other words, what looks like a single brutal quarter of capital spending and pressure on profits is really just the midpoint of a plan the company has already said it intends to keep funding for years to come.

To service the remaining portion of that plan, Alibaba announced a share placement on August 23 worth HK$80 billion, or approximately $10.2 billion, to be used exclusively for Alibaba's "full stack" of AI capabilities: chips, AI computing infrastructure, and the development of advanced AI models. Morgan Stanley, HSBC, UBS, and China International Capital Corp jointly ran the offering as bookrunners. The offering is the largest primary follow-on share sale ever conducted by a Hong Kong-listed company, and the third-largest of its kind anywhere in the world this year, behind only Alphabet and Intel, both of which raised funds for their own AI buildouts around the same stretch of this year. Alibaba's offering drew about $28 billion in demand for the $10.2 billion on offer, nearly three times as much demand as shares available.

Why This Matters Beyond Alibaba

This is the same tradeoff showing up at company after company across the AI buildout right now: real, current profit traded away for a bet on future dominance in AI and cloud computing. Alibaba's version of it is just unusually stark, because a 75% profit decline is not the kind of thing that gets quietly buried by a large capex line item in an earnings release. It is exactly the kind of number that grabs attention, which is why it is the headline here rather than a footnote. The real question is whether Alibaba's growth underneath that number, 45% cloud growth and 12 consecutive quarters of triple-digit AI product revenue growth, is strong enough to justify spending this aggressively.

The Bottom Line

In short, Alibaba reported one of its steepest profit declines in years, largely because it chose to accelerate spending on AI infrastructure. The company is roughly halfway through a multi-year, $56 billion investment plan for AI and cloud computing. Will it pay off? Nobody will know for certain for years. But long before this spending finally slows down, it should already be obvious whether Alibaba's cloud business is still growing as fast as it is today.