Look out Alibaba, JD.com is expanding its cloud and AI presence

JD.com (NASDAQ: JD), China’s largest direct retailer and the second-largest e-commerce company, recently partnered with Cloud flame (NYSE: NET) to strengthen your AI and cloud business.

Cloudflare, which secures Internet traffic between clients and servers, entered the Chinese market in 2015 and currently operates in more than 90 countries and 200 cities worldwide. He runs data centers in 17 Chinese cities and maintains a long-standing partnership with the online search leader. Baidu (NASDAQ: BIDU).

JD will expand Cloudflare’s network to 150 additional data centers in China. Cloudflare will design the network, while JD Cloud & AI will provide the capital and infrastructure. The companies hope to complete the project within three years.

JD’s partnership with Cloudflare could expand its often-overlooked cloud business, offering public, private, and hybrid services with more than 300 products, to compete more aggressively against Alibaba (NYSE: BABA), which leads the Chinese cloud and e-commerce platform markets.

Understand JD.com’s cloud business

JD formed the new Cloud & AI unit last December to develop and integrate new AI, analytics and cloud computing services into its logistics and e-commerce platforms. That ecosystem is powered by the Neuhub open AI platform, which launched two years ago to process language, speech, computer vision and machine learning services for retail and supply chain tasks.

JD’s cloud platform serves its own market as well as business and government customers. In its latest annual report, it stated that the platform delivered “solid operating performance” at two major purchasing events in 2019 with zero disruptions, and was certified as a “AAA Trusted Cloud Provider” by the Chinese Academy of Information Technology. and Communications (CAICT) for two consecutive years.

JD was ranked 10th in China’s public cloud service in the first half of 2019, according to IDC. That makes him a distant loser in the market compared to Alibaba, Tencent (OTC: TCEHY), Chinese telecommunication, Amazon Web Services (AWS) and Huawei, which together controlled 75.3% of the entire market.

JD has yet to disclose its revenue from Cloud & AI separately, but noted that expanding that business would likely increase its R&D expenses as it hired “additional senior and experienced technology employees.”

How does this agreement benefit JD and Cloudflare?

JD’s agreement with Cloudflare will initially reduce its margins as it builds the network. But after the new data centers go online, Cloudflare will pay JD to use that infrastructure, generating a new stream of recurring revenue for the cloud and AI business. Cloudflare, which already redirects traffic for Baidu, will further strengthen its role as “middle man” for Internet traffic in China.

Cloudflare’s network keeps Chinese data centers separate from foreign data centers to increase connection speeds and dispel security and privacy concerns. For example, visitors to a website in China would be served by Cloudflare’s national data centers, while foreign visitors would be served by its nearest data center.

Should Alibaba worry?

Alibaba’s cloud revenue increased 62% annually in the last quarter and represented nearly 7% of its top line, fueled by strong demand for its public and hybrid cloud services. That feverish growth should continue for the foreseeable future and widen its trench against underdogs like JD.

However, Alibaba’s cloud business is not profitable either, and it relies heavily on the profits of its core trading business to continue growing. That’s different from Amazon, which subsidizes the growth of its e-commerce business with AWS earnings.

Unlike JD, which expects its revenues to increase at least 10% annually in the first quarter, as the blockade measures paralyzed most of China, Alibaba expects its core business revenues to decrease. That slowdown could accelerate the expansion of Alibaba’s cloud business in China and overseas markets.

JD Cloud won’t threaten Alibaba Cloud on its own, but Tencent, China’s second-largest cloud player, is also one of JD’s top investors. Tencent’s share of China’s cloud infrastructure market increased from 15.4% to 18% between the first and fourth quarters of 2019, according to Canalys, as Alibaba’s share fell from 47.3% to 46 ,4%.

Tencent’s ecosystem is already deeply intertwined with JD’s, so it’s certainly possible that the two companies could pool their cloud resources to challenge Alibaba. AlphabetGoogle, which also has a significant stake in JD, could also lend a hand.

The bottom line

JD and Cloudflare’s team won’t move the needle for any of the companies anytime soon, but it could light a slow fire under JD’s cloud business, and Tencent’s extra fuel could help it gain ground against Alibaba. Alibaba investors don’t need to worry about JD yet, but they need to be on the lookout for that strategic shift.