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3 Things to Know About Alibaba's Least-Profitable Business

Alibaba (NYSE: BABA) is the top e-commerce and cloud company in China. Its core commerce and cloud units generated 85% and 8% of its revenue, respectively, last quarter. Its digital media and entertainment unit accounted for 6% of its revenue, and the remaining 1% came from its innovation initiatives unit.

Only its core commerce division is profitable, and its profits subsidize the losses at its other three divisions. However, the digital media and entertainment unit consistently posts the steepest losses, and many of its fragmented pieces don't complement Alibaba's e-commerce and cloud businesses.

Let's discuss three key things investors should know about Alibaba's least-profitable business.

Alibaba CEO Daniel Zhang.

Alibaba CEO Daniel Zhang. Image source: Alibaba.

1. It includes 10 distinct businesses

Alibaba uses its digital media unit as a defensive moat against its two main rivals in the tech ecosystem war in ChinaBaidu (NASDAQ: BIDU) and Tencent (OTC: TCEHY). The division now includes 10 businesses which it either acquired or developed over the past five years: UC, UC News, Youku, Tudou, AliMusic, Alisports, Tmall TV, Damai, Alibaba Games, and Alibaba Pictures.

Alibaba launched Alibaba Pictures in 2014 to produce shows and movies in China and abroad. That same year, Alibaba gained the UC mobile browser and UC News aggregator app through its acquisition of UCWeb in 2014, which led to the development of its Shenma mobile search engine.

In 2015, Alibaba acquired the video streaming platform Youku Tudou, which was formed from the merger of two separate services three years earlier. It also launched its streaming music platform AliMusic and its sports subsidiary Alisports, which licenses rights for sporting events, organizes venues, and sells sports event tickets.

It further expanded its ticketing business by buying the online ticketing platform Damai in 2017. It also established a video gaming unit, Alibaba Games, later that year. Lastly, it launched Tmall TV as a live-streaming extension of its Tmall marketplace to let merchants interact with shoppers.

2. It's never been profitable

Alibaba's digital media and entertainment unit posted an operating loss of 3.3 billion yuan ($470 million) last quarter. It's never been profitable, and it's unlikely to squeeze out a profit anytime soon.

Digital media and entertainment unit Q2 2019 Q3 2019 Q4 2019 Q1 2020 Q2 2020
Revenue (in RMB) 5.9 billion 6.5 billion 5.7 billion 6.3 billion 7.3 billion
Operating income (in RMB) (loss) (4.8 billion) (7.1 billion) (3.9 billion) (3.2 billion) (3.3 billion)

Source: Alibaba quarterly reports.

By comparison, Alibaba's core commerce unit generated an operating profit of 32.1 billion yuan ($4.6 billion) last quarter, as its cloud and innovative solutions units posted operating losses of 1.9 billion yuan ($270 million) and 3.1 billion yuan ($440 million), respectively.

Alibaba's cloud platform and innovative solutions unit (which produces hardware devices like smart speakers and its mapping app) both seem like natural extensions of Alibaba's ecosystem. But many of the digital media unit's fragmented list of services (except for Tmall TV) don't fit cohesively into Alibaba's core commerce or cloud divisions.

Alibaba's offices in Hangzhou, China.

Image source: Alibaba.

3. It's not winning the ecosystem war

None of Alibaba's digital media services lead their respective markets. The UC browser remains a distant second in the mobile browser race in China behind Chrome, while Shenma ranks third behind Baidu and Sogou in the search market.

Youku Tudou remains far behind Tencent Video and Baidu's iQiyi in the on-demand streaming video market, and AliMusic is dwarfed by Tencent Music in the streaming music market. Alibaba Games also remains a tiny player compared to Tencent and NetEase, which together own seven of the top 10 highest-grossing iOS games in China, according to App Annie.

Alisports and Damai also face pressure from Tencent's expanding ecosystem of "mini-programs" on WeChat, the most popular mobile messaging app in China. Many online ticketing services already operate within that ecosystem of over 1 million apps.

Alibaba Pictures still produces major movies, but several big releases -- including Gemini Man, UglyDolls, and Asura -- fell short of expectations. Box office returns are notoriously unpredictable, so it doesn't make much sense for Alibaba (or its rival Tencent Pictures) to stay heavily invested in this market.

Will Alibaba sell or spin off this money-losing unit?

Alibaba claims that the digital media unit's long-term strategy is "to integrate entertainment into our overall offerings to consumers beyond commerce," and that it saw "positive results" from its investments in original content last quarter.

Therefore, it seems unlikely that Alibaba will spin off or divest this money-losing unit anytime soon. Alibaba might consider it a necessary defense against Tencent and Baidu, but it will likely remain a dead weight on its earnings for the foreseeable future.

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Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Baidu, NetEase, and Tencent Holdings. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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