Alibaba is trading higher profit margins for accelerated growth in its artificial intelligence business through a significant increase in capital spending.

On August 20, Alibaba Group released its results for the first quarter of fiscal year 2027, which corresponds to the second quarter of the 2026 calendar year. During the period, the group reported revenue of RMB 268.953 billion, marking a 9% increase year-on-year and exceeding the anticipated RMB 268.52 billion. However, with continued investment in AI infrastructure, profitability faced notable pressure. Operating income declined by 57% year-on-year to RMB 15.161 billion, while non-GAAP net income fell 38% to RMB 20.715 billion.

Meanwhile, AI and cloud operations emerged as the standout highlights of this earnings report. Alibaba's cloud segment saw external commercialization revenue grow 45% year-on-year, hitting its fastest pace in 22 quarters. Revenue from AI-related products reached RMB 12.376 billion for the quarter, marking the 12th consecutive quarter of triple-digit year-on-year growth. The adjusted EBITA for the AI cloud and computing services division surged 133% year-on-year, with its profit margin improving to 12%, indicating that the AI business is achieving a combination of rapid growth and enhanced profitability.

Another key growth driver came from instant retail. Revenue from China's instant retail segment climbed 45% year-on-year to RMB 53.295 billion, making it the fastest-growing business within the e-commerce division.

At the same time, Alibaba is entering a phase of heavy capital expansion. Capital expenditures for the quarter reached RMB 67.678 billion, a 75% increase year-on-year, while free cash flow recorded a net outflow of RMB 44.67 billion. The sustained investment in AI computing power, chips, and data centers has become a primary factor weighing on short-term profitability.

During the quarter, Alibaba reorganized its business segments, consolidating its operations into four major divisions: Alibaba E-commerce Group, AI Cloud and Computing Services, AI Labs and Applications, and All Other. Specifically, Cloud Intelligence Group and T-Head Semiconductor were integrated into the AI Cloud and Computing Services division, while the Qwen model, Qwen App, and Qwen Office were grouped under AI Labs and Applications.

The new structure reinforces AI's central role within Alibaba's business framework. From chips and computing power to large models and applications, Alibaba is accelerating the integration of its entire AI value chain, making the revenue, investment, and profitability of its AI-related businesses more transparent.

Alibaba Cloud Achieves Highest Revenue Growth in 22 Quarters, With Improved Profitability

AI cloud and computing services became the most closely watched business segment this quarter.

In the quarter, Alibaba Cloud's external commercialization revenue grew 45% year-on-year, the fastest pace in 22 quarters, accelerating from the 40% growth recorded in the previous quarter. Revenue from AI-related products reached RMB 12.376 billion, marking the 12th consecutive quarter of triple-digit year-on-year growth, underscoring sustained strong AI demand.

Even more notable was the improvement in profitability. The adjusted EBITA for the AI cloud and computing services division hit RMB 5.628 billion, up 133% year-on-year, with its profit margin rising to 12%. This indicates that Alibaba Cloud is not only expanding revenue from AI computing and cloud services but also beginning to realize economies of scale and operational leverage.

At the chip level, T-Head has developed a comprehensive full-stack system covering GPUs, CPUs, and network chips. Its latest-generation AI processor, Zhenwu M890, has achieved commercial deployment through Alibaba Cloud, currently serving more than 20 industries including autonomous driving, internet, and finance, with over 650 external customers.

Computing infrastructure on the supply side is also expanding in tandem. Alibaba Cloud has compressed the delivery cycle for large-scale AI data centers to 100 days and expects the production efficiency of its self-developed modular data centers to more than double this year to meet the escalating demand for AI computing power.

From chips to cloud, and from data centers to models, Alibaba is building a more complete AI infrastructure ecosystem.

Instant Retail Surges While Traditional E-Commerce Faces Pressure

The e-commerce group generated revenue of RMB 205.862 billion this quarter, up 4% year-on-year, though performance varied significantly across its business lines.

Among them, China's instant retail revenue reached RMB 53.295 billion, a 45% increase year-on-year, making it the fastest-growing segment within the entire e-commerce group. Taobao Flash Purchase maintained its market share while continuously optimizing unit economics, while Hema benefited from expansion into emerging cities and synergies with Taobao Flash Purchase, achieving double-digit growth in both orders and revenue.

In contrast, China's traditional e-commerce revenue declined 8% year-on-year to RMB 110.9 billion, with customer management revenue down 7%. However, due to accounting treatment changes arising from the new marketing development plan, the year-on-year figures are subject to comparability impacts; excluding these factors, customer management revenue grew approximately 1% on a like-for-like basis.

International e-commerce revenue dipped slightly by 1% year-on-year to RMB 27.761 billion, but AliExpress achieved operating profit this quarter, signaling improved profitability.

Overall, the e-commerce group's adjusted EBITA reached RMB 39.749 billion, down only 1% year-on-year, as growth and efficiency gains in instant retail partially offset the pressures faced by traditional e-commerce.

Qwen Investment Intensifies, AI Applications Weigh on Short-Term Profits

While AI cloud is emerging as a new growth and profit engine, AI applications remain in a high-investment phase.

This quarter, the AI Labs and Applications division posted an adjusted EBITA loss of RMB 13.861 billion, compared to a loss of RMB 3.224 billion in the same period last year, more than tripling the loss scale. This was primarily driven by rising inference costs for the Qwen App and increased investment in AI capabilities.

User adoption continues to expand rapidly. Since its launch, over 250 million users have experienced AI-driven shopping scenarios through the Qwen App's intelligent agent features, with ecosystem synergies with Taobao Tmall and Taobao Flash Purchase accelerating. However, the rapid growth in user scale and model capabilities also implies higher inference costs. With AI applications still in their scale-expansion phase, model training, inference, and product iteration will continue to pressure short-term profits.

This highlights the current dual nature of Alibaba's AI business: AI cloud is already demonstrating revenue growth and profitability improvement, while AI applications are still trading profits for user and ecosystem scale.

R&D Spending Surges, One-Time Charges Further Compress Profits

The pressure on profitability does not stem solely from the AI business itself; changes in the cost structure and one-time items have also had a significant impact.

Alibaba's cost of revenue reached RMB 254.081 billion this quarter, with the cost ratio rising to 61.8% from 55.1% in the same period last year, mainly due to the increased revenue share from cloud and AI businesses as well as changes in the accounting treatment of marketing revenue. Product development expenses climbed to RMB 22.529 billion, up 50% year-on-year, with the proportion of revenue rising from 6.1% to 8.4%, reflecting the company's continued investment in AI R&D personnel and technology infrastructure.

Additionally, one-time charges further dragged down operating income. General and administrative expenses rose to RMB 12.708 billion, with the proportion of revenue increasing from 2.5% to 4.7%, primarily due to a RMB 550 million provision for fines related to the EU's Digital Services Act. The company also recognized a goodwill impairment of RMB 4.458 billion.

Consequently, operating income fell 57% year-on-year this quarter, impacted not only by structural factors such as increased AI investment but also by one-time items including the fine provision and goodwill impairment.

Quarterly Capital Expenditure Reaches RMB 67.678 Billion as AI Enters a Heavy Capital Cycle

Cash flow data more directly illustrates Alibaba's strategic choices.

As of the end of June, the company held RMB 474.505 billion in cash and other liquid investments, maintaining ample liquidity. However, capital expenditures reached RMB 67.678 billion this quarter, up 75% year-on-year, while free cash flow recorded a net outflow of RMB 44.67 billion, significantly wider than the RMB 18.815 billion outflow in the same period last year.

The increase in capital expenditure is primarily linked to AI computing procurement, higher CPU computing demand, and rising chip component prices.

Notably, net cash generated from operating activities still reached RMB 22.945 billion, up 11% year-on-year, indicating that the core business's cash generation capability has not deteriorated. The substantial swing to negative free cash flow is more a result of surging capital expenditures.

Meanwhile, share buybacks during the quarter were limited to just USD 162 million, a marked contraction from previous periods. During this phase of massive AI investment, Alibaba is prioritizing capital allocation toward computing power, chips, and data centers rather than shareholder returns.

For Alibaba, the core changes in this earnings report are clear: traditional e-commerce growth is slowing, but AI cloud is accelerating as a new growth and profit engine. At the same time, the company is proactively entering a heavy capital investment cycle, sacrificing some short-term profits and cash flow to secure long-term competitive advantages in AI infrastructure and full-stack capabilities.