Quick Take
Kingsoft Cloud Holdings (NASDAQ:KC) has filed to raise $425 million from the sale of ADSs representing underlying ordinary shares, per an amended F-1/A registration statement.
The company provides enterprises in Asia with a suite of cloud-based service offerings.
KC has produced revenue growth but no gross profit and is generating large operating losses and operational cash burn. I'll be watching this IPO but not participating.
Company & Technology
Beijing, China-based Kingsoft was founded to provide enterprises with complementary cloud services as an alternative to their on-premise information technology systems. Kingsoft is a spinoff from Hong Kong-listed Kingsoft Corporation (HK:3888).
Management is headed by Chief Executive Officer Mr. Yulin Wang, who has been with the firm since 2012 and was previously EVP at Phoenix New Media Limited and COO at CNEC.
Below is a brief overview video of the Kingsoft Cloud antivirus system:
Source: languy99
The company’s primary offerings include:
Compute
Networking
Storage & CDN
Database
Data Analysis
Security
Kingsoft has received at least $1.1 billion from investors including parent firm Kingsoft, Xiaomi and FutureX.
Customer Acquisition
Kingsoft is the largest independent cloud service provider in China and focuses its efforts by industry vertical: gaming, video and financial services.
The firm seeks marquee customers in each vertical to be able to demonstrate its capabilities and market more efficiently to other prospects in the vertical.
Selling and marketing expenses as a percentage of total revenue have been dropping as revenues have increased, as the figures below indicate:
Selling & Marketing | Expenses vs. Revenue |
Period | Percentage |
2019 | 8.0% |
2018 | 8.6% |
Source: Company registration statement
The Selling and Marketing efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Selling and marketing spend, was a very strong 5.3x in the most recent reporting period.
Market
According to a 2020 market research report by Allied Market Research, the global market for cloud services of all types reached a value of $265 billion in 2019 and is expected to reach $928 billion by 2027.
This represents a forecast 16.4% from 2020 to 2027.
The main drivers for this expected growth are a large and continued transition by enterprises worldwide from on-premises systems to cloud environments and ongoing innovation in cloud system offerings by service providers.
A Frost & Sullivan report commissioned by Kingsoft shows the expected growth of various sectors in China as shown in the chart below:
Financial Performance
Kingsoft’s recent financial results can be summarized as follows:
Sharply growing topline revenue
Little gross profit and low gross margin
Large and growing operating losses
High and increasing cash used in operations
Below are relevant financial metrics derived from the firm’s registration statement:
Total Revenue | ||
Period | Total Revenue | % Variance vs. Prior |
2019 | $ 568,295,000 | 74.2% |
2018 | $ 326,201,765 | |
Gross Profit (Loss) | ||
Period | Gross Profit (Loss) | % Variance vs. Prior |
2019 | $ 1,108,000 | -103.8% |
2018 | $ (29,469,118) | |
Gross Margin | ||
Period | Gross Margin | |
2019 | 0.19% | |
2018 | -9.03% | |
Operating Profit (Loss) | ||
Period | Operating Profit (Loss) | Operating Margin |
2019 | $ (164,258,000) | -28.9% |
2018 | $ (144,033,088) | -44.2% |
Net Income (Loss) | ||
Period | Net Income (Loss) | |
2019 | $ (166,755,000) | |
2018 | $ (257,193,235) | |
Cash Flow From Operations | ||
Period | Cash Flow From Operations | |
2019 | $ (63,074,000) | |
2018 | $ (56,339,706) |
Source: Company registration statement
As of December 31, 2019, Kingsoft had $290.6 million in cash and $358.2 million in total liabilities.
Free cash flow during the twelve months ended December 31, 2019, was a negative ($206.6 million).
IPO Details
KC intends to sell 25 million ADSs representing ordinary shares at a midpoint price of $17.00 per ADS for gross proceeds of approximately $425 million, not including the sale of customary underwriter options.
Existing and external shareholders have indicated an interest to purchase shares of up to $125 million at the IPO price, an unusual signal of support by investors.
Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO would approximate $4.2 billion.
Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 12.5%.
Per the firm’s most recent regulatory filing, the firm plans to use the net proceeds as follows:
approximately 50% to further invest in upgrading and expanding our infrastructure;
approximately 25% to further invest in technology and product development, especially in artificial intelligence, big data, cloud technologies and internet of things;
approximately 15% to fund the expansion of our ecosystem and international presence;
and approximately 10% to supplement our working capital for general corporate purposes.
Management’s presentation of the company roadshow is not available.
Listed underwriters of the IPO are J.P. Morgan, UBS Investment Bank, Credit Suisse and CICC.
Commentary
Kingsoft is seeking significant U.S. public capital investment as it spins out of parent firm Kingsoft.
The firm’s financials show strong revenue growth, breakeven gross profit, large & increasing operating losses and growing use of cash in operations.
Sales and marketing expenses as a percentage of total revenue has dropped and the sales and marketing efficiency rate is a strong 5.3x.
The market opportunity for helping enterprises transition from on-premises systems to the cloud is an extremely large and multi-decade market, so the firm enjoys favorable tailwinds in terms of market dynamics.
On the legal side, like many Chinese firms seeking to tap U.S. markets, the firm operates within a VIE structure or Variable Interest Entity.U.S. investors would only have an interest in an offshore firm with contractual rights to the firm’s operational results but would not own the underlying assets.
This is a legal gray area that brings the risk of management changing the terms of the contractual agreement or the Chinese government altering the legality of such arrangements. Prospective investors in the IPO would need to factor in this important structural uncertainty.
Comparing KC’s proposed Enterprise Value /Revenue multiple of 7.48 to the NYU Stern School’s aggregate basket of publicly held Software (System & Application) category, which had an EV/Sales multiple of 8.77 in January, 2020, the IPO appears reasonably valued from that perspective.
However, the firm has barely been able to generate gross profit, let alone operating or net profit.
It is common to see high growth enterprise software firms generate significant gross profit while producing operating losses.
KC is producing no gross profit plus generating large operating and net losses.
While I’m bullish about the industry the firm is in, I can’t get too excited about its financial results, so I'll pass on the IPO.
Expected IPO Pricing Date: May 7, 2020.
Gain Insight and actionable information on U.S. IPOs with IPO Edge research.
Members of IPO Edge get the latest IPO research, news, and industry analysis. Get started with a free trial!
