● Both Alibaba's revenues and adjusted-EBITA have been consistently growing, and in the fourth quarter of 2020, Alibaba Cloud's adjusted-EBITA turned positive for the first time.

● Pingtouge's appearance was the result of market progress and self-improvement through massive R&D spend. 

● Pingtouge benefited hugely from Alibaba's cross-industry clout.

● Even though a number of drivers have accelerated Pingtouge's development, it still faces risks from rising costs and competitors. 

The largest chipmaking project of Alibaba Group (NYSE: BABA), Pingtouge engages with core developments in Internet functions and Cloud services, assisting the Hangzhou-based e-commerce giant to strengthen its presence in the technology market. 

On July 24, 2020, Pingtouge announced that it had developed the country's first full-chain smart contract processor customized to power AntChain's business as a primary chip infrastructure provider. Thus far Pingtouge has achieved significant results in improving semiconductor chips. For instance, on July 25, 2019, the company released its RISC-V processor, the XuanTie 910, for a handful of applications including autonomous driving.

Here, we discuss the rationale behind creating Pingtouge, the place of the chipmaker in Alibaba's growing ecosystem, and the main risks facing the company. We are bullish on Alibaba, and its chip project is one of the reasons for our positive stance.

Financial analysis

According to Alibaba's latest financial statements, there has been a dramatic upward trend in its profits. Specifically, from 2018 to 2020, the growth rate of its revenues was about 86.58%. Relating to the revenue structure, its core segments include Tmall, Taobao, and Cainiao, accounting for around 85.94% of 2020's total. Moreover, when compared with Alibaba's different sectors by adjusted-EBITA, only the core commerce sector had positive values during these three years. In other words, the core commerce sector's profits offset other sectors' losses. 

In assessing Alibaba Cloud, we notice its progressive gains in 2020, overturning losses through successful business operations. In the last two years, especially after Pingtouge was founded, Alibaba Cloud had higher costs overall. Nevertheless, in the fourth quarter of 2020, this sector eventually yielded positive results, proving that the former input was worthwhile. 

Pingtouge's inevitable appearance

Why did Alibaba decide to establish Pingtouge? There are four main reasons worth highlighting.

 Firstly, Alibaba's e-commerce business is gradually reaching its ceiling. By the second quarter of 2019, Alibaba's active consumers in China reached 730 million, while China's active consumers attained approximately 1 billion. This reflected the Internet industry's new tendency – that a given demographic dividend will gradually disappear. Alibaba and other Internet firms should find other areas to break out in. In this circumstance, Alibaba realized there was a big room for development based on high-tech areas, such as Cloud computing, AI, and blockchain. Hence, it started investing in chip firms like Cambricon, adding Pingtouge to Alibaba Cloud to develop chips. 

Secondly, external threats are looming. In late 2020, the US began to obstruct China's chip supply, starting with a crackdown on SMIC. Seeing the acute need for self-developed semiconductor capabilities, giant companies in China started investing lavishly in R&D for chips. For instance, Alibaba's founder, Jack Ma, put a lot of effort into this field and eventually founded Pingtouge. 

Thirdly, the question of structure presents another problem. In general, most chip firms use ARM structures, a family of reduced instruction set computing (RISC) architecture models for computer processors; they have typically been asked to buy another IP core. However, Pingtouge utilizes the RISC-V structure, which is an open standard instruction set architecture (ISA) relying on established reduced instruction set computer (RISC) principles. This structure entails an IP core within chips without the need for external suppliers. Furthermore, Pingtouge lowers chip design R&D periods and costs. With Pingtouge's IP core, firms can begin to customize design and innovation. 

Fourth, the rising Cloud service market is shaping the playing field. The competition pattern of Cloud computing has changed from IT costs to computational competition. By taking this situation into account, customized chips will bring stronger computation ability to customers. Additionally, as China's Cloud service market is expected to show an upward trend by 2023, firms like Alibaba intend to put more effort into developing chips.

Internal strength 

Alongside the above opportunities, Pingtouge's own endeavors are also helping it to grow. To begin with, the company is constantly seeking innovation. Not only has the semiconductor unit of Alibaba collaborated with other firms, but it also worked with internal teams in Alibaba to improve efficiency. As for the external collaboration, Pingtouge cooperated with Allwinner Technology, a Chinese chipmaker, to produce open-source processors, The company's innovations can be located in industrial control, intelligent home design, and consumer electronics. With Pingtouge's RISC-V structure, Allwinner Technology will release the first RISC-V SoC (system on a chip) in 2021. As for internal cooperation, Pingtouge is working with the Ant Group and infrastructure server team from Alibaba Cloud, stepping into the field of blockchain. 

Diversification trends demonstrate Pingtouge's strength further. Alibaba Cloud's solid structure makes it more competitive in the domestic market. Morgan Stanley even increased its estimated value to CNY 540 billion in 2020. Precisely, Alibaba Cloud's distribution in Cloud computing, AI, chip, AIoT, automatic driving, quantum computing, and blockchain all help to strengthen its roots in the technology tree. Among these roots, chips are the most crucial factor for Alibaba's Cloud services, as other services rely on self-developed chips.

Potential risks

Although Alibaba Cloud has attracted immense attention, it still faces two major risks. The first risk concerns rising expenses. Alibaba's increasing revenues come along with increasing expenses, bringing negative revenues in some sectors. Surprisingly, the highest expenses came from operating costs, and even market expenses were higher than R&D expenses. Alibaba's higher expenditure on its media coverage might confuse some customers – i.e. whether the firm wishes to develop chips or lift up share prices.

Secondly, there are threats from competitors. Over the past two years, Alibaba Cloud has occupied the top position in the China public Cloud market,  mainly including IaaS, SaaS, and PaaS. However, most of Alibaba Cloud's market shares came from IaaS, whose growth rate will gradually slow down in the future. On the contrary, the new growth points should be obtained from SaaS and PaaS. According to Frost & Sullivan, PaaS's market scale will reach CNY 60 billion in 2022, contributing more to the Chinese Cloud service market. Additionally, PaaS is the main driving force for Tencent Cloud, which is Alibaba Cloud's top competitor. 

Bottom line

Compared with its retail business, Alibaba Cloud's contribution is not conspicuous and there are still some significant risks. However, with its market potential, this business might become Alibaba's other support in the future. Following the shock of COVID-19, online work and entertainment have pushed Cloud growth. China's 'new infrastructure'-related projects have also played an essential role. 

Pingtouge's self-developed chips are key in the tech giant's growing ecosystem and have already proven to be a solid long-term investment. In the middle of regulatory struggles, it's essential for Alibaba to have globally competitive technology tools that allow the firm to negotiate with the state properly. Pingtouge is one.