Corporate reorgs are never easy. 

When Alibaba proposed its “1+6+n” corporate reorg in March, breaking up the giant into one single holding company with six loosely held, somewhat independent businesses, plus a cohort of other assets (the “n”), it was the mother of all reorgs. At the time, I gave both a charitable and a cynical interpretation of what this undertaking could mean for Alibaba’s future. Since I’m naturally optimistic, I ended up taking the charitable side of the equation.  

So far, it’s been a hot mess and not going well, proving that the cynical version is more prescient. Since the initial reorg announcement, the status of Daniel Zhang, its CEO before the reorg, went from leading both the holding company and AliCloud, to just being CEO of AliCloud, to resigning entirely and just making venture investments off the corporate balance sheet. Joe Tsai became the group’s chairman. Eddie Wu became the group’s CEO. Wu also took over AliCloud from Zhang, but only on an acting basis. Freshippo, its groceries retail chain and one of the “n’s”, was gearing up for an IPO, but that has been put on hold. Cainiao, its domestic and international logistics unit, has filed its paperwork for a Hong Kong IPO, but the listing hasn’t been priced. Given this year’s difficult IPO market overall (see Arm, Instacart, Klaviyo’s share prices), it’s hard to predict Cainiao’s fate.

And in this week's earnings announcement, Alibaba shared that it is no longer going to spin off AliCloud into a separate publicly traded company. When asked during the earnings call whether this pan is temporary or permanent, Joe Tsai deftly answered the question by not answering the question. Sounds pretty permanent to me.    

“1+6+n” is now “1+5+(n-1)”.

This latest backtracking on AliCloud’s spinoff sent $BABA stock price plummeting, even with the SEC’s Uptick Rule or Rule 201 triggered, which limits short selling in volatile trading situations. In fact, I feel bad for its communications and investor relations teams – dealing with all this back and forth could not have been easy. 

AliCloud’s spinoff cancellation is the latest, and arguably most consequential, development that’s affecting the company’s prospects. It also happens to be the one business unit I care about and have watched closely over the last three-plus years. So let’s look at whether this latest chapter of reorg hot mess makes sense or not.

Reasonable Reasoning?

The official reason given for canceling the spinoff is: “in light of uncertainties created by recent U.S. export restrictions on advanced computing chips.” Is this reasoning…reasonable?

Yes and no.

Yes, in the sense that when the Commerce Department announced an expanded export control ban on AI chips to China on October 15, the new rules undoubtedly turned the “small yard, high fence” doctrine into “big yard, higher fence”. Life was already hard for Chinese tech companies, big and small, trying to out-compete (or just not fall too far behind) their American counterparts in building and training foundation AI models. After this expanded ban, things got even harder; AliCloud was no exception. 

No, in the sense that this expanded ban was by no means a big surprise and was well anticipated. Thus, claiming an element of surprise and explaining away the spinoff cancellation on the expanded ban alone lacks credibility. After all, when the prospect of an AliCloud spinoff was first made public back in March, the unit had already been dealing with the first version of the chips ban for six months, which took effect in October 2022. It has since been stockpiling H800 chips, the once ok but now banned Nvidia modified GPUs to its H100 series, along with Tencent Cloud, ByteDance, and all its other peers. So it is hard to believe that Alibaba itself didn’t see this coming. 

So what else could explain this sudden reversal? Financial engineering gone awry.  

When asked about this during the earnings call Q&A, Joe Tsai said this:

“About the – our announcement to not proceed with the full spin-off, for us, when we announced the full spin-off, we were looking at a weighted sort of a financial engineering way to show the value of the business…But the circumstances have changed. And right now, rather than focus on financial engineering, we rather focus on figuring out how to grow the cloud business.”

Giving credit where credit is due, Tsai is at least honest and transparent about it. The spinoff was a financial engineering play all along, not a new corporate arrangement aimed to improve and boost the growth prospect of an otherwise promising technology platform. This play fell apart when the cloud unit’s revenue, excluding services provided to other Alibaba units like Taobao and Cainiao, declined this quarter. Based on our analysis, this is only the second time the cloud unit suffered this type of revenue decline, since Alibaba began breaking down revenue per each of its six major units in May 2019.

For the sake of argument, in an imaginary world where AliCloud had somehow completed its spinoff and independently listed on say the NASDAQ or HKEX, releasing an earnings report that shows revenue decline for a major cloud provider would send its share price down the drain. 

Sadly, you can’t financially engineer away declining growth.

A “Value” Stock Future?

Alibaba is stepping into the classic identity crisis of a mature-ish tech company, where it has to straddle a growth narrative and a shareholder value narrative.

These two narratives are quite often in conflict with each other. This conflict was evident in the narrative of its earnings release. On the one hand, executives mentioned multiple times the need to use its financial strengths to make more investments in an AI-driven world to capture this new innovation wave and achieve more sustainable growth. On the other hand, the company approved an annual dividend to shareholders for the first time in its history, worth roughly $2.5 billion USD. This dividend is on top of the company’s share repurchase program, which still has $14.6 billion left to spend.

Dividends usually signal a lack of investment ideas or growth trajectories, thus giving money back to the shareholders is the best use of that cash – the value narrative. If there are promising investment areas or growth trajectories, then aggressively putting that cash to work instead of issuing dividends is the path forward – the growth narrative. Even the most cash-rich tech companies may not pay a dividend, if growth is the focus. Neither Google nor Amazon issues dividends. 

Both narratives are perfectly fine, depending on which direction the company wants to go. But it is nearly impossible to tell both narratives credibly at the same time.

What is not narrative are the numbers on a balance sheet. As of the end of September 30, Alibaba’s cash or cash equivalents stand at $85.6 billion USD or 42% of its market cap. That’s a big pile of dry power. And it is not clear at this moment if Alibaba knows what to do with it. 

As John Maynard Keynes once said, “When the facts change, I change my mind.” I’ve shared in our Q3 2023 performance letter how we’ve been thinking about and assessing Alibaba. Well, facts have undoubtedly changed since I published that letter. In light of its reorg hot mess, we will most definitely be reassessing our view of Alibaba and change our minds accordingly.