Kingdee reported overall in-line 1H24 results amid slow economy and enterprise IT spending backdrop. The increase in contract liability to RMB3.4bn (+6% HoH) and net cash position affirmed the successful transition of subscription business model. We are positive on Kingdee’s order wins of large SOEs in 1H24, which should bring long- term growth, although the actual project implementation may delay due to various reasons. We maintain our FY25 breakeven target unchanged. Maintain BUY with TP lowered to HK$8.5 (was HK$13.9) due to overall slow IT spending.
　　Key Factors for Rating
　　1H24 results highlight: Revenue grew 12% YoY. GPM improved 1.3ppts YoY to 63.2%, OPM improved 4.1ppts YoY to -11%, broadly in line with consensus. The improving OPM was a result of 1) increasing mix of subscription revenues and 2) improving medium and SME client margins. Net loss recorded RMB218m from RMB284m in 1H23.
　　By cloud segments: Large enterprise business (Cloud Cosmic/Constellation): Revenues declined 7% HoH to RMB546m and NDR was lowered to 97% due to weakness in both upsell and new sign-up as many enterprises have been undergoing a series of business restructuring and downsizing. Medium enterprise business (Cloud Galaxy): revenue grew 14% YoY and 2% HoH with OPM sustained at 20%. NDR was 95%, -2ppts HoH. SME business: revenue grew 17% YoY. NDR of Cloud Stellar improved to 92% (was 91% in 2H23).
　　ARR growth brings in strong cash inflow: In 2023, net operating cash was RMB653m and mgmt. guides 2024 net operating cash to exceed RMB900m driven by higher mix of subscription revenues. In 1H24, ARR was RMB3.2bn, up 24% YoY; Cloud contract liabilities were RMB3.1bn, up 21% YoY; subscription contract liabilities were RMB2.7bn, up 28% YoY. Amid current weak overall macro, we view Kingdee’s key operating matrix is quite resilient. Management maintains 2025 bottom line breakeven target unchanged.
　　Domestic substitution demand to sustain next year growth: We expect the IT system domestic substitution in China’s large enterprise will continue as evidenced by Kingdee’s notable order wins in 1H24 despite macro slowdown. We expect Kingdee will be among the key beneficiaries with its established cloud product matrix and ecosystem. As Kingdee’s large enterprise mix is increasing and many large enterprises delay the project implementation into 2H, we expect 2H24 revenues to grow 27% HoH to RMB3.6bn.
　　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 2024/25/26 sales by 1%/1%/2% to reflect weak IT spending and delay in project implementation, offset by the increased demand for license software. Our valuation is based on SOTP, which we apply 4x 2025E P/S (was 8x 2024E P/S) to Cloud Services business, and 8x 2025E P/E to Management Software business (was 12x 2024E P/E). Our new target price is HK$8.5 (previously HK$13.9). Maintain BUY.