Alibaba’s ( BABA ) rapidly growing advertising segment is often overlooked by investors. This segment has shown substantial growth in the past few quarters which has allowed Alibaba’s ad revenues to overtake entire TV ad spending in China. Alibaba has tried to increase its advertising revenues through number of initiatives. These include new AI tools , partnership with Kantar , investment in digital media services and many more. The future potential of the advertising segment is very strong as more services, media and commerce options are added on Alibaba’s platform.

Although Alibaba faces a big threat from Pinduoduo (PDD) and growing partnerships from Tencent/Wal-Mart/JD combine, it is still expanding its market share in important segments. By grabbing a greater market share in advertising compared to rivals, Alibaba can rely on this segment to improve its margins and promote its own services and products.

Source: eMarketer

Constant upgrade

Alibaba is trying to build a significant lead over other competitors by forming new partnerships and launching new initiatives within advertising segment. It recently launched AI tools which can be used to develop advertising copy for its clients. By using this tool businesses can see different advertising ideas for their products. They can then evaluate which ideas produce the best results. This tool substantially reduces the turnaround time in building new advertising copies and testing their impact. Fashion label Espirit is already using this tool to adjust the ads according to the needs of the product. Alibaba has also claimed that this tool is being used a million times a day by small to mid-size companies.

These tools provide greater control over Alibaba’s customers for advertisers who can now see the real-time impact of new marketing ideas on a single platform. This ends up increasing the loyalty for Alibaba and also provides it with a strong revenue stream in the future. Alibaba’s AI tool uses the gargantuan amount of data gathered by the company from its 600 million customers. This would be very difficult to replicate for any company.

Alibaba has also announced a new partnership with Kantar to develop new marketing tools. Kantar will benefit from Alibaba’s sizable data collecting ability whereas Alibaba will benefit from the trust and recognition built by Kantar within this segment. Kantar is a subsidiary of WPP, British multinational advertising agency.

These new tools and partnerships can make Alibaba an indispensable advertising option for its clients. This will also lead to a higher share of marketing budget devoted to Alibaba’s platform instead of other options like TV and rivals like Baidu (BIDU) and Tencent. The report by eMarketer mentions that the combined revenue of Baidu and Tencent from advertising was 19% of the total ad spend in China. On the other hand, Alibaba has cornered over one-fifth of the total ad market.

Growth potential

The future growth potential of e-commerce giants like Alibaba and Amazon within advertising is very high. They benefit from the network effect where they collect ever-increasing data points on a customer’s shopping habits. Alibaba has a strong edge when compared to social media giant Tencent in this department. Although customers spend a lot more time on Tencent’s social network, Alibaba captures data directly related to the sale of the products. This is the main reason why Tencent is aggressively moving into commerce segment through stronger partnership with JD.com (JD) and investment in Pinduoduo.

According to an e-commerce report, Alibaba is already ahead of TV ad spending in China. It will continue to see rapid growth for the next few years with annual revenues touching $30 billion in 2020.

The overall margins within this segment are much higher than physical retail where Alibaba has been investing. A rapidly growing adverting segment will help in reducing some of the negative margin impacts due to Alibaba’s entry into physical retail.

Currently, Alibaba’s Digital media and entertainment segment is its biggest money loser. This segment had adjusted EBITA loss of $414 million in the last quarter on total revenue of $840 million. Alibaba has an option to show more targetable ads to customers using its digital platform compared to other competitors. Alibaba’s AI efforts and heavier investment in content can certainly help in lifting the advertising revenue from the digital media segment.

The importance of advertising and digital media was emphasized by the company in the last quarter results. It said, “The synergy between our commerce business and entertainment can deliver a superior user experience while increasing customer loyalty and subscription revenue, as well as return on investment for advertisers”.

According to the above report of eMarketer, Alibaba is forecasted to corner one-fifth of the total ad budget in China in 2018. Its main digital competitors Baidu and Tencent will together account for 19% of total ad spend. This is one area where Alibaba is much ahead of its U.S. counterpart Amazon (AMZN). While Amazon’s ad revenue is only $3-4 billion, Facebook (FB) is close to $40 billion and Google’s (GOOG) ad revenue is at $100 billion. This shows the grip Alibaba has in advertising segment within China.

The report by eMarketer also predicts that the current pace of advertising growth will continue for the next few quarters. By 2020, Alibaba is forecasted to increase its advertising revenue by 50% from 2018 numbers. The margins in this segment are much better than physical retail and cloud operations. The continuous growth in Alibaba’s advertising ecosystem will solidify its place as the market leader in China.

Investor Takeaway

A lot of attention is not paid to the advertisement segment of Alibaba but this is one of the most promising areas for the company. Alibaba has cornered close to one-fifth of the total ad spend in China. It is also developing new tools and partnerships to leverage the huge amount of customer data that it collects. Having good advertisement growth should allow the company to run other segments at lower margins.

Segments like food delivery through Ele.me or digital media might be a drag on EBITA for some time but they help in attracting more customers to Alibaba’s platform. These customers can then be delivered targeted ads which end up reducing the losses these segments would have on a stand-alone basis. As Alibaba expands its presence in international locations, these tools and partnerships can be very useful in developing a strong advertising business outside China.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.