Da cook
Elevator pitch
My review for KINGSOFT CLOUD HOLDINGS LIMITED (Nasdaq: KC) (3896:HK) is a buy. I have analyzed Kingsoft Cloud’s financial performance for Q4 2023 through the previous update written on March 22, 2024.
The focus is on improving KC’s forecasts Current article. Kingsoft Cloud has reached an inflection point, as evidenced by strong growth in its AI-related revenue and EBITDA profitability in the first quarter. With KC returning to positive expansion in total revenues and EBITDA remaining positive, the stock should see a positive rerating of its valuations. As such, I have made the decision to upgrade my review of Kingsoft Cloud from Hold to Buy.
AI revenue will be the main driver of growth
Kingsoft Cloud’s prospects are becoming more favorable as AI revenues grow.
KC’s RMB revenue contraction narrowed from -19% y/y in Q4 2023 to -5% y/y for Q1 this year, as shown in Q1 Earnings release. Going forward, the sell side expects that Kingsoft Cloud could turn from a revenue decline of -14% last year to record +5% (Source: Standard & Poor’s Capital IQ) Top line increase for 2024 in local currency.
My opinion is that analyst expectations for Kingsoft Cloud to achieve positive revenue growth in the current year are realistic, considering its AI revenue growth driver.
In the company’s first-quarter earnings release, KC revealed that its AI-related revenue as a percentage of its total public cloud segment rose from 8% in Q4 2023 to 13% in Q1 2024. For reference, public cloud represents the segment and the services segment Enterprise cloud accounted for approximately two-thirds and one-third of Kingsoft Cloud’s total revenue, respectively, in the latest quarter. In absolute terms, Kingsoft Cloud’s AI revenue jumped +93% QoQ to CNY160 million in 1Q24.
There are good reasons to expect KC’s AI revenues to expand further in the future and represent a larger percentage of the public cloud sector’s top line in the future.
On its Q1 2024 analyst call in late May, Kingsoft Cloud noted that “AI companies are now building out their core stack on our cloud” and are expected to “expand their new stacks on the cloud” in the coming quarters. This bodes well for KC’s AI revenue outlook in the short term.
In the medium to long term, KC believes that its AI-related revenue growth will be driven by new areas in which AI can be used and new customer groups.
Specifically, KC noted in the company’s first-quarter results conference call that “AI computing power” will likely be used outside of “computing” for various “application and data scenarios” in the future. Also, new customers from the “financial services, legal and audit industries” and “public sector”, as well as existing technology industry customers, could be a major driver of AI revenue growth according to Kingsoft Cloud’s earnings call commentary.
Positive EBITDA can be maintained
KC achieved first-quarter EBITDA profitability in the first quarter of 2024.
In specific terms, Kingsoft Cloud reversed a non-GAAP adjusted EBITDA loss of -28 million CNY in Q4 2023 to record positive EBITDA of 33 million CNY in the first quarter of 2024. KC is expected to report earnings before interest, taxes, depreciation and amortization (EBITDA) of CNY287 million this year correspondingly. With a non-GAAP EBITDA loss of -CNY265 million for the prior year, according to consensus forecasts derived from Standard & Poor’s Capital IQ.
I am of the view that KC can maintain positive EBITDA for the coming quarters and the full year (like what the market has expected), due to a better mix of revenues and good cost management.
One element of Kingsoft Cloud’s improved revenue mix is the increased contribution from artificial intelligence. In the previous section, I highlighted that KC’s AI revenue contribution is growing rapidly and represented a significant 13% of the company’s total earnings in the latest quarter. Notably, the company referred to its “AI business” as “high margin” in its first-quarter analyst briefing, so the increase in AI revenue should translate into better profitability for KC as a whole.
The other element in KC’s top mix improvement is the continued decline in revenue derived from its less profitable CDN (content delivery network) business. The company was able to reduce the top line contribution of its CDN business from half of its total sales in the past to 23% (Source: Q1 earnings call) for the latest quarter.
On the other hand, Kingsoft Cloud’s revenue and SG&A (general and administrative) costs decreased by -11% YoY and -21% YoY, respectively, for Q1 2024 in RMB. In its latest quarterly earnings report, KC attributed the decline in costs last quarter to a focus on “procurement pricing” in selecting suppliers and “strict control of daily operating expenses.” As Kingsoft Cloud continues to aggressively manage costs and optimize its supply chain network, the company’s expenses should continue to decline.
Main risks
Investors should monitor these two risk factors when considering a potential investment in Kansas City.
First, future total Kingsoft Cloud and AI revenues could come in below expectations if AI-related demand weakens.
Second, KC may fail to deliver positive EBITDA in the coming quarters, assuming the company doesn’t execute well on its cost optimization plans and shrinking its CDN business.
Concluding thoughts
The market currently values Kingsoft Cloud at consensus FY2025 EV/EBITDA and enterprise value-to-sales multiples of 4.9x and 0.32x, respectively, according to Standard & Poor’s Capital IQ Data. I see the company’s stock as undervalued and deserving of a buy rating.
KC has found a new growth driver in the form of AI-related revenue, and has turned a corner on EBITDA profitability. As such, my view is that Kingsoft is worth trading at a single-digit EV/EBITDA metric and an enterprise value-to-revenue ratio of at least 0.5x, in light of its improving outlook.
