Kingsoft (OTCPK:KGFTY) had already attracted my attention in the past, but back then, I didn’t see enough value to warrant a position. However, since Kingsoft recently spun-off its cloud operations into Kingsoft Cloud (KC), which is now quoted in the Nasdaq, I decided to take another look.
The reason for this second look came from the fact that we could be reasonably sure that American investors would value Kingsoft Cloud richly. In turn, this could mean that the remaining assets held by Kingsoft could be valued as a bargain. This article is the result of a said second look.
Kingsoft After The IPO
After both the IPO (which diluted Kingsoft’s ownership on Kingsoft cloud) and a small spin-off of some additional shares, Kingsoft retained approximately 42% of Kingsoft Cloud.
On top of this, Kingsoft also retained two segments:
- Online gaming
- Office software
Additionally, Kingsoft has ~$1.42 billion in net cash.
Kingsoft Cloud Valuation
Now that Kingsoft Cloud is a public corporation, we can use its market value to value Kingsoft’s shareholding. The ~42% that Kingsoft retains on Kingsoft Cloud is thus worth ~$1.84 billion.
Kingsoft Cloud is still a loss-making enterprise, and it also carries a quite low gross margin (less than 5%). However, it’s on track for at least ~$0.68 billion in revenues, with these growing at ~35-50% YoY (the estimate is based on the lower end of that range).
At $0.68 billion in run-rate revenues, it trades for ~6.4x revenues. This isn’t very stretched in the current tech bubble, but, at the same time, it’s very stretched if the business doesn’t become much more profitable. Anyway, our main concern is to consider the market value of this Kingsoft Cloud stake.
What About The Rest
The rest of Kingsoft consists of a large net cash position (~$1.42 billion) as well as the “remaining business” (online gaming, office software).
With Kingsoft trading at HKD$24.90, this gives it a market cap of ~$4.4 billion. If we remove from this market cap the net cash ($1.42 billion) and the value of the Kingsoft Cloud stake ($1.84 billion), we arrive at a value for the remaining business (online gaming, office software) of ~$1.15 billion.
Now, if we annualize Kingsoft’s Q1 2020 operating profit, we come to a possible operating profit for the remaining business of ~$198 million. This would have Kingsoft’s “remaining business” trading at ~5.8x EBIT, which is actually cheap.
- Q1 2020 was highly favored by the coronavirus situation, leading to stronger demand both for online gaming and for office software. Annualizing this might be overly optimistic.
- The 5.8x EBIT multiple is reliant on Kingsoft Cloud being worth what it trades for. Kingsoft will look much cheaper if Kingsoft Cloud moves up but much more expensive if it moves down. The Kingsoft Cloud stake presently represents 41.8% of Kingsoft’s entire market cap.
- Due to the presence of a large net cash pile as well as the large Kingsoft Cloud value, changes in the “remaining business” valuation doesn’t have a huge effect on the overall Kingsoft valuation. For instance, if this “remaining business” saw a repricing to two times higher valuation than the present (to ~11.6x EBIT), the impact on the overall Kingsoft share ought to be upside of just 26%.
Finally, if we were to value Kingsoft on a sum-of-the-parts, then it would also likely trade at a discount to those parts (we didn’t apply any discount above). This would make Kingsoft less attractive still.
While Kingsoft remains an interesting story, the company itself doesn’t trade incredibly cheaply. Even without a discount for its disparate parts, the valuation only seems “reasonable”.
Kingsoft is presently gaining from the coronavirus situation. It could benefit from the tension between China and the U.S., which could lead to widespread replacement of Microsoft software for Kingsoft’s solution. It’s hard to separate the effects from this, from the short-term effects brought about by coronavirus.
Also, the office segment is very small (around 1/3rd of the “remaining business”). This means that it’s hard to base a bullish thesis on 1/3rd of 26% (the “remaining business'” weight on overall valuation) of the current value of Kingsoft shares.
As a result, Kingsoft doesn’t seem like a potential investment. At most, it looks like a potential speculation.
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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.