Alibaba's profits decreased by 75% as its quarterly expenditure on AI reached $10 billion.

      Alibaba’s net profit dropped 75% in the June quarter, reaching $1.54 billion. This decline was not due to poor business performance; rather, it was the result of hefty investments in business development. Capital expenditures soared to $9.98 billion over three months, representing a 75% increase compared to the same period last year, as detailed in the results announcement. Notably, the cloud sector supported by this spending reported a segment profit up 133%.

      Revenue increased by 9% to $39.64 billion, slightly exceeding the LSEG consensus of RMB 268.88 billion, as reported by CNBC. In contrast, free cash flow experienced a significant outflow of $6.58 billion, compared to an outflow of $2.77 billion the previous year. Following the market opening, Alibaba’s US shares dropped by around 5%.

      The cloud segment is performing well, with AI Cloud and Compute Services generating $7.14 billion, a 45% year-on-year increase. This marks the division’s fastest growth in 22 quarters, according to the South China Morning Post. Revenue from AI-related products reached $1.82 billion, showing triple-digit growth for the twelfth consecutive quarter. The unit also reported profitability, with an adjusted EBITA of $830 million, up 133%. Chief Financial Officer Toby Xu reported the EBITA margin for the cloud segment at 12%. Furthermore, Alibaba Cloud captured the largest share of China’s AI cloud market at 38.1%, according to research firm Omdia.

      However, there is a caution regarding the comparisons made, as Alibaba restructured its reporting segments this quarter by integrating the chip unit T-Head into the cloud division and creating a new unit for its model labs and consumer AI applications. While year-on-year figures were adjusted for consistency, they do not align with the segments previously modeled by analysts.

      Regarding the rise in capital expenditures, the company cited three reasons: fluctuations in procurement cycles, increased CPU compute capacity in anticipation of AI agent adoption, and rising prices for various chip components, reflecting the same pressures affecting other Chinese hardware companies this quarter. This investment is what led to the negative cash flow, with property and equipment purchases totaling $9.97 billion against an operational cash flow of $3.38 billion. This pattern mirrors Meta’s previous quarter, where AI capital expenditures impacted cash flow while Microsoft turned similar expenses into cloud revenue. Alibaba is simultaneously pursuing both strategies.

      The new AI Labs and Applications segment encompasses the model labs, the Qwen consumer application, and the QwenWork agent. This new segment generated $492 million in revenue, a 16% increase, but recorded a loss of $2.04 billion at the adjusted EBITA level, compared to a loss of $475 million the previous year. The company attributed these losses to investments in AI and the operational costs of running the Qwen application’s inferences.

      Alibaba is not alone in facing challenges. Tencent recently increased its own AI expenditures substantially, which unsettled investors. Analysts noted this concern as well. Citigroup mentioned that the rising capital expenditures and negative free cash flow could raise worries regarding capital requirements and investment returns. Bloomberg Intelligence took it further, projecting that AI would continue to depress returns for leading Chinese AI firms, predicting that Alibaba’s AI business would incur cash losses for the next three years.

      In response, Chief Executive Eddie Wu presented a counterargument during the analyst call, asserting that the AI business's ability to self-fund and sustain itself is strengthening, which gives the company increased confidence in continued investments. He provided figures indicating that annualized revenue from AI products is expected to reach nearly $10 billion this quarter, up from about $7.3 billion from April to June, as reported by Bloomberg. Executives expressed optimism about recouping the overall AI investment within the three-year timeframe established for early 2025, when they pledged over RMB 380 billion.

      The headline figure of a 75% profit decline can be misleading. Non-GAAP net income, which excludes share-based compensation, investment fluctuations, and impairments, fell by 38% to $3.05 billion. Adjusted EBITA of $4.03 billion exceeded expectations. The Nikkei interpreted this quarter as falling short of estimates, while the South China Morning Post considered it a beat, reflecting different perspectives on the same financial results.

      One significant figure overlooked in the day's coverage was the increase in general and administrative expenses, which rose to 4.7% of revenue from 3.0%. The company clarified that this spike was due to a provision for the European Commission’s Digital Services Act fine of €550 million, imposed on AliExpress in July as its largest enforcement action under the DSA to date, which is now reflected in the group's accounts. Additionally, a separate goodwill impairment of $657 million related to the All Others segment also impacted the results.

      Alibaba also announced the release of the weights for Qwen3