Where Can the Chinese Internet Go?

With all the executive orders, CFIUS edicts, and additional sanctions placed on Chinese tech companies by the US, it’s hard to see where these companies - and by extension the Chinese Internet - can expand to. Certainly, China’s own economy will continue to grow, providing a meaningful amount of business and opportunities. But that won’t be enough to satisfy either the investors’ need for growth or the companies’ own raw ambitions.

So where can the Chinese Internet go to expand?

We can find some clues from the major Chinese cloud providers’ expansion plans, particularly Alibaba and Tencent. I’m focusing on cloud expansion as an indicator, because it is capital intensive (e.g. building data centers) and longer-lasting (you can’t just pack up and abandon a data center when things don’t work out -- it’s commercial real estate!). Cloud infrastructure is also a good proxy for the Internet as a whole, because all online services will eventually be run on the cloud, one way or another.

Alibaba and Tencent Cloud

Alibaba and Tencent Cloud are not only the two leading public cloud providers in China, they also have meaningful market shares around the world.

In Gartner’s newly released worldwide Infrastructure-as-a-Service (IaaS) market share report earlier this month, the top five are:

• AWS
• Azure
• Alibaba
• Google
• Tencent

Alibaba is the clear number 3, while Tencent made the cut at number 5. Notably, Tencent’s IaaS revenue grew by over 100% from 2018 to 2019, albeit from a small base. Other providers who may have bigger brand names, like IBM Cloud and Oracle Cloud, do not have big enough market shares to deserve their own rows in the spreadsheet.

According to Gartner, if we combine IaaS with Platform-as-a-Service (PaaS), Alibaba would still be at number 3 globally, while Tencent and Oracle would be in a virtual tie at number 5.

(These cloud acronyms can get confusing, so here’s a plain term definition of IaaS and PaaS. IaaS is data center hardware for rent; think raw server, storage, and networking capacity, maybe with a layer of virtualization on the bare metal machines. PaaS is the layer above IaaS, where the cloud vendors provide common building blocks for applications for rent: think containers, databases, logging, etc. I’m glad Gartner will combine these two categories in future analysis, because the line is basically indistinguishable and somewhat meaningless.)

With this current state of play in mind, let’s look at the massive amounts of investment both Alibaba and Tencent plan to make in their cloud unit. Back in April, Alibaba announced it plans to spend $28.2 billion USD to expand its cloud infrastructure in the next three years, which I explored in-depth in “Alibaba vs IBM: Fighting for Third Place in Cloud”. Not to be outdone, Tencent announced in May that it’ll invest $70 billion USD in the next five years to do the same.

Let’s put these eye-popping numbers in context. IBM’s acquisition of Red Hat two years ago, a pure cloud play to expand IBM’s hybrid cloud capabilities, was $34 billion USD, which was a 63% premium of Red Hat’s pre-acquisition valuation of roughly $21 billion USD. This was one of the largest acquisitions in tech history. Alibaba basically plans to build another Red Hat. Tencent plans to build two. And if you take Gartner’s analysis at face value, both are already materially ahead of IBM Cloud.

I understand that this comparison with Red Hat’s acquisition is a bit crude, but I hope it illustrates the pure magnitude of Alibaba and Tencent’s cloud investments. A big portion of these investments will go into China’s own rapidly growing cloud market. According to Canalys, China’s cloud infrastructure spending grew by 66.9% in Q4 of 2019 and by 63.7% for the entire year to exceed $10.7 billion USD, making it the second-largest cloud market in the world.

Given how closed China’s Internet economy is to outside players (AWS is the only non-Chinese cloud provider with a foothold), this growth will only benefit domestic companies.

Both Alibaba and Tencent Cloud already have many data centers outside of China. The new investments will likely be global. The only other Chinese cloud vendor that has a decent global presence is Huawei Cloud. However, considering the late-breaking new round of sanctions earlier this week that targeted all of its overseas cloud and R&D units, including the ones in Southeast Asia, Latin American, Europe, and Africa, Huawei will be in survival mode, not expansion mode, for the foreseeable future.

Southeast Asia, Latin America, Middle East

I chose Southeast Asia, Latin America, and the Middle East, because of their long-term economic potential and Alibaba and Tencent Cloud’s existing presence there, making them probable expansion destinations, even with all the geopolitical tensions swirling around us. I’m leaving out India -- an otherwise great expansion target -- because of its recent banning of many Chinese apps and intense animosity towards Chinese tech.

There are the data center maps of Alibaba and Tencent Cloud, respectively, as they stand today:

It’s important to look at cloud services longitudinally (or vertically) on a map, because time zone differences combined with geographical distance matter a lot for performance, user experience, and delivering timely customer support.

To illustrate this more concretely, data centers in North America plus customer successes teams can reasonably serve users in Latin America. Indeed, many American cloud providers do exactly that, until market traction is big enough in Latin America to justify building local data centers. The same can be said for data centers in Europe serving Africa, or data centers in India serving the Middle East.

Southeast Asia: as I described in detail in “Southeast Asia and the Pacific Light Cable Network”, the ASEAN region has a vibrant and burgeoning digital economy. There is a data center construction boom in Singapore. Some regional Internet giants started using Chinese cloud providers from the get-go -- Shopee on Tencent, Tokopedia on Alibaba (and later added GCP). Other major players use the leading American counterparts -- Gojek on GCP, Grab on AWS and Azure. Because the digital economy there is young, most of these startups are cloud-native to begin with. Given the existing inroads that Alibaba and Tencent have already made in the region, with strategic investments, acquisitions, and product expansion, Southeast Asia is a natural and relatively mature target to expand their cloud units further. Both existing cloud capacities in China and data centers in Southeast Asia can serve customers. Alibaba has also announced its plan to add a 3rd data center in Indonesia in 2021.

Latin America: Chinese tech firms, like ridesharing platform Didi Chuxing, have gained traction in Latin America, where local political and cultural resistance is not as strong as in the US. The continent’s overall cloud market is also projected to grow 38.3% CAGR between 2018-2023, according to IDC. Tencent already has a colocation presence in Sao Paulo, where most of the continent’s cloud data centers are situated. Both Alibaba and Tencent have an assortment of data centers in the US that probably have idle capacity to serve Latin American customers, because they are effectively shut out of the US market. Latin America also has an emerging digital economy with marquee players like Brazil’s Nubank, one of the largest neobanks (or pure digital banks) in the world. (Worth noting that Tencent has also been building its own neobank, WeBank.) I would not be surprised to see announcements by either Alibaba, Tencent, or both, building their first dedicated cloud data center in Latin America in the next two to three years.

Middle East: in terms of GDP per capita, the Middle East is roughly at the same level as Latin America. Israel has a very active tech scene with seven unicorns to date. Careem, the super app that combines ridesharing, payment, and delivery, spans most markets in the Arab world and was acquired last year by Uber for $3.1 billion USD. Zomato, the India-based food delivery service backed by Ant Financials, also has significant market presence in the Middle East. Alibaba has been eyeing the region for quite some time with a Dubai data center that came online in 2016. It entered the Turkish market with a partnership in 2018. Even though the Indian market’s sentiments have turned sour in the last few months, the two giants’ cloud capacities in India can serve its Middle Eastern customers just fine. As far as geopolitics is concerned, there is perhaps no single region (generalizing of course) that has more misgivings towards the US than the Middle East. The enemy of my enemy is my friend (and customer).

Land Grab Now, Profit (Much) Later

So far I’ve painted a fairly rosy picture of expansion opportunities. But the harsh reality is all these destinations are still quite poor, where meaningful revenue will not be generated for a long time. As shown in this chart of GDP per capita by regions, all areas of Asia, Latin America, and the Middle East trail the US and EU by a wide margin.

Although GDP per capita is typically a proxy for consumer spending, it can also serve as a signal for enterprise spending, since much of it is dictated by meeting consumer demands anyways.

For what it’s worth, the vast majority of the cloud industry is still in “land grabbing” mode, not “profit taking” mode. Everyone is focused on building out physical infrastructures and grabbing market share for now. That’s why most of the major cloud vendors, including Microsoft, Google, Oracle, IBM, and certainly Alibaba and Tencent, do not disclose any operating income (i.e. profit) that directly attributes to their cloud businesses. Instead, they report rough topline revenue numbers or just growth rates within dubious, non-standardized categories: “Commercial Cloud” (Microsoft), “Google Cloud” (Google), “Cloud & Cognitive Software” (IBM), and “Cloud Services and License Support” (Oracle). They are all likely losing a lot of money and will continue losing money in the foreseeable future.

The only exception is AWS, who reported a whopping $9.2 billion USD of operating income for its fiscal year 2019, where North America accounts for more than 75% of that income.

To “land grab”, offering bulk discounts of up to 80% in exchange for signing long-term (3+ years) deals is common in the cloud industry. An even more extreme example: according to Reuters, in 2017, Tencent apparently offered to complete a cloud project for the Fujian provincial government for a grand total of 0.01 yuan. Getting workload is the name of the game; revenue and profit must wait.

Thus, the Chinese Internet led by Alibaba and Tencent still have room to expand around the world. Smaller Chinese startups, who are in either Alibaba or Tencent’s orbit, can also expand on the backs of their cloud infrastructures to gain users and market share. But none of them will be making serious money from those expansions any time soon. Being shut out of the most lucrative markets of North America and parts of Europe hurts. A lot.

The big question is now (repackage a John Maynard Keynes saying): can geopolitics remain irrational longer than you can remain profitless?

If you like what you've read, please SUBSCRIBE to the Interconnected email list. New posts will be delivered to your inbox (twice per week). Follow and interact with me on: Twitter, LinkedIn.