Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.
Late last week a Chinese company called Kingsoft Cloud filed to go public in the United States. The cloud infrastructure business intends to list on the Nasdaq under the symbol “KC,” with J.P. Morgan, UBS and Credit Suisse helping out with running the deal.
Kingsoft Cloud has a $100 million placeholder figure in its F-1 filing, giving us an idea of its expectations for the size of the public offering. According to Crunchbase data, Kingsoft Cloud raised nearly $1 billion while private.
There are a few questions to answer:
- Does Kingsoft compete with Alibaba’s cloud projects that the Chinese tech giant just promised to spend $28 billion building out?
- Is it an economically viable business?
- What are we supposed to think about an IPO in this economy?
What does Kingsoft Cloud do?
Kingsoft Cloud is a China-focused cloud infra provider that has a little over 5% market share in the country, according to its own math. In its F-1 filing, the company says that it also sells “well-architected industry-specific solutions across public cloud” and “enterprise cloud and AIoT cloud services.” You can dig into those terms as much as you want, but what really matters is that, in the infrastructure as a service (IaaS) and platform as a service (PaaS) markets (spaces where Microsoft’s Azure and Amazon’s AWS compete), Kingsoft Cloud has a piece of the Chinese market.
It’s a space that is anticipated to grow quickly as China’s economy and digital footprint expands. For example, Alibaba’s cloud revenue grew 62% in the last year. Kingsoft Cloud agrees, saying that “China’s cloud market is at an early stage with tremendous growth potentials as indicated by the lower market penetration as compared to that in the United States.” That argument could be attractive to investors; if you think that China’s cloud penetration will eventually match that of the United States’s own, then putting capital into one of its players might make sense.
But what about Alibaba? How can Kingsoft Cloud take on the huge company with its brand, cash and incumbency? Well, Kingsoft has a positive spin on its status as not one of China’s biggest tech empires:
Being an independently operated company, focusing on cloud services since our inception, we are able to fully mobilize our resources into the innovation of our business models and provide high-quality services to businesses and organizations of all kind. With our full dedication to cloud business, we are able to avoid potential conflicts of interest with our customers and enhance our neutral position, which in turn gains additional trust from more and more customers.
Maybe!
Kingsoft Cloud is largely owned by Kingsoft Group — a Beijing-based public software company — and Xiaomi, a Chinese hardware company. Kingsoft Group owns 53.8% of the company before the IPO, while Xiaomi owns a smaller 15.8%. Other investors in the business include Yuri Milner, FutureX Capital, Forebright Capital and Shunwei Capital per Crunchbase.
Let’s see if its business is any good.
Financial results
Is it a good business? Not so far.
Kingsoft Cloud generated $568.3 million in 2019 revenue, including $496.8 million in “public cloud services,” the vast majority of its top line. Its full revenue result grew by 78.4% in 2019, similar to its 79.5% growth it registered in 2018 when that year was compared to its 2017 result.
That growth has come at a rising cost, with Kingsoft Cloud posting growing losses during its life. In 2019 the firm posted its largest ever operating loss of $164.3 million, up 47.8% from its 2018 operating loss.
The firm’s operating costs came to $165.4 million in 2019, effectively the same figure as its operating loss. How is that possible? It turns out that Kingsoft Cloud effectively sells its services at cost; the firm generated a mere $1.1 million in gross profit in 2019, or 0.2% of its revenues. That means it has gross margins of 0.2% for the whole year. That’s catastrophically bad but somehow still an improvement.
In 2017 and 2018, the company posted -9.6% and -9.0% gross margins, meaning that it sold its services for less money than it cost to deliver them. Seeing it go gross margin positive in 2019, then, is a material improvement. The company generated gross margin of 4.6% in Q4 2019, the most recent financial period it detailed. So, we can see the firm growing nicely, and improving its gross margins, even if it’s still a mess of a business.
After a billion dollars in capital, Kingsoft Cloud has only managed to reach gross margin neutrality! What a world.
Kingsoft Cloud’s net losses fluctuate depending on a few factors, including forex gains and losses, making its operating losses more useful for our understanding. Is this a business that can afford to keep operating? Kingsoft Cloud had $290.6 million in cash at the end of 2019 and only burned $63.1 million in cash during 2019. The answer is yes, for a while yet.
But its private investors are turning to public markets now instead of putting more of their own capital into the business. It’s not exactly a vote of confidence, as they are pushing it live into the public markets when the IPO window is expected to be closed. A sure-shot, profitable, slam-dunk this company is not, making its IPO timing all the more interesting.
Why now? I don’t know.
We’ll keep tabs on the offering, especially its expected F-1/A filing that should include Q1 2020 data. If the company can keep the growth pumping while showing more gross margin improvement, its IPO could go over well. But I did not expect to see a gross margin break even Chinese cloud company try to go public in the United States in Q2.
As nothing here makes sense, it’s hard to have real expectations. More when we have it.