SenseTime announced (4 Dec) the completion of a strategic organizational restructuring, after which the company has established a new “1+X” structure: 1) “1” stands for the core business, which will focus on AI cloud services, integration of large models & AI applications, development of general computer vision (CV) models; 2) “X” stands for other ecological businesses within the group including smart auto, domestic robot, smart healthcare, smart retail, etc. Each ecological business will 1) designate an independent CEO; 2) have a flexible incentive mechanism and financing channels; 3) use SenseTime’s AI infrastructure & large models (and pay SenseTime on an arm's length transaction basis) to develop AI applications in their respective fields. We expect the restructuring will help SenseTime focus on its generative AI business, accelerate its progress to achieve breakeven and unleash the value of its ecological businesses. We revise up our earnings forecast and now expect SenseTime to achieve breakeven in FY26E (previous: adjusted net loss of RMB1.7bn). We raise our TP to HK$2.00 based on 9.0x FY25E EV/Sales (previous: HK$1.36 on 6.5x FY25E EV/Sales). Maintain BUY.
　　Focus on core AI Cloud and Gen AI businesses. Upon restructuring, SenseTime will focus on the core AI Cloud and Gen AI businesses, the revenue of which grew by 256% YoY and accounted for 60% of the total revenue in 1H24. We also expect meaningful expense cuts, as the total headcount of core business is below 2,000 and represents less than 50% of the Group headcount before restructuring (4,672 as of 1H24). The ecological businesses, including smart auto/domestic robot/smart healthcare/smart retail etc, will focus on the AI applications opportunities in their respective fields. The ecological businesses together have c.2,000 employees. Depending on the financing and divesture progress, some ecological businesses will be deconsolidated from SenseTime financial statements, but these ecological businesses will continue to use SenseTime AI infrastructure, pay SenseTime on an arm's length basis and drive SenseTime’s Gen AI revenue growth.
　　Upbeat on Gen AI business growth. We forecast Gen AI business revenue to grow at a CAGR of 68% over FY24-26E, mainly driven by SenseTime’s growing compute power and robust demand for AI compute. SenseTime is the third largest Gen AI IaaS service providers in China in 2H23, with a market share of 15%, per IDC. The company has total operating computing power of over 20,000 PetaFLOPS in Aug 2024 (+233% YoY), and management expects it to surpass 25,000 PetaFLOPS by end- FY24. Supported by its strong AI infrastructure, we are upbeat that SenseTime will continue to benefit from the development of Gen AI.
　　Expect breakeven by FY26E. Due to the restructuring, we are now more positive on SenseTime’s breakeven trajectory. We forecast its adjusted net margin to improve from -79.6% in FY24E to +1.1% in FY26E, fuelled by the robust Gen AI business growth and significant decline in opex. With a more sustainable business model, we see SenseTime as better positioned to capture opportunities in the new AI era.