Kingdee International
　　GPT to reform and benefit Kingdee SaaS
　　Kingdee reported overall in-line 2H23 results in a slow market with enterprises delaying IT spending. We are positive on Kingdee’s HR/Finance/Tax software market share gain among the large domestic enterprises and on Kingdee GPT’s monetisation potential. Enterprises are accelerating in the AI race and software vendors like Kingdee can add huge value. Meanwhile, Kingdee’s 74.5% operating cash inflow growth in 2023 well demonstrates its decade long SaaS transformation has now started paying off. We are more positive on its future profitability improvement. Reiterate BUY with TP slightly lowered to HK$13.9 due to overall slow economy.
　　Key Factors for Rating
　　2H23 results highlight: Revenue grew 17% YoY. GPM improved 3.6ppts YoY to 66%, OPM improved 4ppts YoY to -1% beating BOCIe. The better profitability is due to growing subscription-based revenue with a better operating leverage. NI recorded RMB74m from -RMB33m in 2H22 while the full year 2023 remained in loss for RMB210m.
　　By cloud segments: Large enterprise business (Cloud Cosmic/Constellation): NDR was stable at 105% with rising upsell and average contract value but slower client sign-ups upon slow market. Medium enterprise business (Cloud Galaxy): revenue grew 15% YoY with operating margin reaching 22%, which we expect a good profitability proxy for Kingdee’s overall cloud service business entering mature stage. SME business (Cloud Stellar): achieved 20% revenue YoY growth and dollar retention ratio improved to 91% (was 77% in 2H22), showing recovery sign of Chinese SME IT spending.
　　Strong operating cash driven by subscription: In 2023, net operating cash of RMB653m, up 74.5% YoY mainly driven by the subscription/SaaS revenue penetration. ARR was RMB2.86bn, up 34% YoY; Cloud contract liabilities were RMB2.87bn, up 28% YoY; subscription contract liabilities were RMB2.43bn, up 30% YoY. We believe the strong operating cash inflow demonstrates Kingdee’s strong bargaining power as a SaaS provider and market may underestimate its margin elasticity in a recovering economy.
　　Confident guidance driven by SaaS transformation and AI tailwind: Mgmt. published new medium-term guidance over 2024-2026, guiding operation cashflow to grow at 50% CAGR, rev. at 15-20% CAGR and ARR at 30% CAGR, which is powered by SaaS migration and AI. In 2024, Kingdee plans to release 10 LLMs applications in ERP and HR systems utilising existing industry knowhow, data and talent resources. We believe Kingdee has an advantageous position in AI as it could package AI with existing ERP/HR products and deliver to its huge enterprise customer base who generally lacks AI capability.
　　Key Risks for Rating
　　1) Enterprise IT spending slowdown due to macro uncertainty; 2) risk of bottom- line miss due to heavy R&D expenses; 3) risk of rising competition; and 4) unsatisfactory subscription retention.
　　Valuation
　　We cut 2024/25 sales by 3%/4% to reflect latest company guidance and macro economy. Our valuation is based on SOTP, which we apply 8x 2024E P/S (unchanged) to Cloud Services business, and 12x 2024E P/E to Management Software business (was 9x). Our new target price is HK$13.9 (previously HK$15.1). Maintain BUY.