On Friday, we initiated in Kingsoft Cloud. Please keep in mind, KC carries risk as the company has disclosed its earnings statements are not audited. As stated on the forum by our readers, the United States House is set to consider a measure this week to force U.S. listed Chinese companies to comply with audit terms. We cover additional risks below and Knox goes into the levels he is watching and how he plans to manage risk for this particular position.

We want to give a few bullet points here as to why we initiated despite the fact KC.

Overview:

We like Cloud IaaS in China and this is the basis for our Alibaba position. I mentioned this on the forum here. The United States cloud IaaS market is about $45 to $50 billion while China recently surpassed $5 billion – which reveals an important gap for this massive population.

According to some numbers, Kingsoft Cloud is the #3 cloud provider second to Alibaba and Tencent. According to others, Kingsoft Cloud is a close tie with Baidu in the #4 spot. Here is the quote from the S-1 filing: “We are the third largest internet cloud service provider in China with a market share of 5.4% in terms of revenue from Infrastructure as a Service, or IaaS, and Platform as a Service, or PaaS, public cloud services in 2019, according to Frost & Sullivan.”

Kingsoft could see multi-cloud as a tailwind due to being the largest independent cloud provider. Also, companies like Bytedance and iQIYI use KC to avoid using Tencent (direct competitor). The concentration of Bytedance and others is a risk.

Although market is undecided about Xiaomi’s involvement due to large customer concentration, we see this particular customer/backer as a positive. We like the Xiaomi has done well in China and we also like the focus on 5G, video content and health care/medical IoT to help KC find an edge against Alibaba, Tencent and Baidu. Xiaomi is the number two smartphone in China ahead of Apple and we think this resilience is a positive. In fact, we would not have invested without a strong backer in either AI or 5G so Xiaomi as an early investor, co-chairman and 14% of revenue is primary to our interest.

Kingsoft is focused on verticals, such as video streaming, gaming and health care. We like this approach as it shows an understanding of competitive positioning and clear differentiation from the larger competitors.

Kingsoft Cloud is scheduled be added to the MSCI China All Shares Index on November 30th at market close.

Net dollar retention rate is 155% in FY 2019

Revenue increased 72.6% year-over-year. This represents 48.1% growth from public cloud services and 257.3% growth from enterprise cloud services. Some of this was a rebound in enterprise from a covid deceleration. The company is expected to grow revenue 62% next year to $1.62 billion. To compare, Tencent Cloud is in the $3 billion range.

Adjusted gross profit was $16.9 million and adjusted EBITDA of -$3.9 million.

 

Risks

There are currently over 200 Chinese companies that are listed on U.S. exchanges. However, unlike U.S. companies that must comply with strict regulatory requirements, China-based audit firms are not in compliance with the U.S. Public Company Accounting Oversight Board (PCAOB) inspections required under the Sarbanes-Oxley Act of 2002 (SOX Act), which is supposed to apply to all U.S. listed publicly traded companies.  

The NASDAQ is requiring additional listing requirements for Chinese firms, while the U.S. Senate passed S. 945, the Holding Foreign Companies Accountable Act. This Act requires foreign companies to prove that they are not owned by governments, as well as requiring them to disclose to the SEC information that allows the PCAOB to perform inspections.

This change in U.S. regulations was soon followed by the Luckin Coffee fraud. The Chinese competitor to Starbucks admitted to falsifying their sales by roughly $2.2 billion yuan. This not only led to a sharp selloff in the stock, but also caused the NASDAQ to delist the stock.

The above reasons led to valuations in Chinese tech companies that are hard to come by in today’s markets. Because of the above risks, we will still invest in ideas we like, but with risk controls in place. Our two Chinese positions are Alibaba (BABA) and Kingsoft (KC), both of which now have stops in place. This will allow us to participate in the growth stories, while at the same time minimize our exposure to the macro and regulatory risks going on within China today.

The national debt to GDP ratio of the U.S. economy is estimated to be around 98% of GDP by the end of 2020, with the largest increase in government debt. In a similar response to the GFC, the Chinese government also attempted to stimulate their economy through debt, and is currently looking an unsustainable debt to GDP ratio of 317%, with the largest focus in corporate debt.

Basic Technical Analysis

From a basic Technical Analysis perspective, we have a nice base that has formed, which provides a clear breakout zone.

Note the large volume spike accompanied by a long green candle. This suggests that the sellers have dried up, leading to a rush of buyers. Seeing Friday close above $39.25 is promising. The next level of resistance will be $43.

Elliott Wave Analysis

If we dived deeper into the price structure, we can get further support of a potential breakout on the horizon.

The above chart outlines my structural analysis of the current price action in KC. First off, from its all-time low, we have a clear 5 wave move to the ended just below the $43 level. Each wave within this structure (in green on the left), moved along standard extensions, further supporting a wave 1 within a larger uptrend (in blue).

We then saw a symmetrical retrace to the 50% retrace level of the first wave. Once again, we typically see 2nd waves terminate around the 50% retrace level. The structure of this retrace also was symmetrical.  In other words, the length of the c wave in red was around the same length of the a wave in red.

This retrace was then followed by another 5 wave move up, and smaller retrace, suggesting that we are in the early stages of the larger degree 3rd wave in blue. The move on Friday further supported this thesis when we saw a high volume breakout above the $39.25 resistance. If we see a further breakout above the $43 level the above targets will be in effect.

We will use a wider stop than normal in this starter position. We always start small, and if we analyze a trend accurately, which is confirmed by an increase in price, we tend to build on that position along the uptrend. We will have a stop at $31.90 based on the closing price.