Advanced Micro Devices (AMD), Google (GOOG) – SenseTime profits sucked into the R&D vortex

Key points to remember:

  • SenseTime spent up to 2 billion yuan on R&D in the first half of this year, accounting for 144% of its total revenue
  • Declining revenue from its two core businesses and late customer payments led the company to increase its impairment provisions by more than 50%

By Ken Lo

SenseTime Group Inc. (0020.HK) could be the first among China’s four “AI Tigers”. But its healthy appetite for R&D spending should keep it trapped in a sea of ​​red ink for some time to come.

Among China’s leading AI companies, SenseTime ranks above its three biggest rivals, CloudWalk Technology (688327.SH), Megvii Technology and Yitu Technology, in computer vision artificial intelligence (AI). The company provides its technology to governments and businesses for applications such as smart cities, surveillance and autonomous driving.

Its crown jewel is its SenseCore platform, which is powered by huge amounts of data and a deep learning algorithm that can deliver services at different levels and price points for various industries. SenseCore’s total computing capacity has been significantly enhanced with the commissioning of the company’s next-generation AI data center (AIDC) in Shanghai earlier this year, enabling SenseTime to enter the race with global giants technology like Alphabet GOOG and Microsoft MSFT in computer vision AI. But SenseCore has also become a financial sponge, and it’s far from clear that the big R&D outlay will translate into enough new business to justify the expense.

Heavy R&D spending meant there was no magic turnaround for SenseTime’s money bleed temp worker results in the first six months of this year. During the period, the company lost 3.21 billion yuan ($465 million), which was lower than the loss of 3.71 billion yuan in the previous year. But its non-GAAP adjusted loss soared 265% to 2.56 billion yuan from a loss of 703 million yuan in the same period last year.

SenseTime said the flood of red ink was primarily due to its growing investment in R&D, combined with write-downs of financial and contractual assets and foreign exchange losses.

Low demand

SenseTime’s R&D spending has skyrocketed over the past four and a half years, from 849 million yuan in 2018 to 3.61 billion yuan last year. It is on track to stay on that trajectory this year after hitting 2.04 billion yuan in the first half of 2021 alone, positioning it to break the 4 billion yuan barrier for the full year.

Continued Covid-control disruptions in China in the first half of this year dragged the company further down the loss-making rabbit hole, with revenue down 14.3% year-on-year to 1.42 billion yuan . In the end, R&D spending accounted for 144% of the company’s revenue over the period, well above the average for large AI companies.

SenseTime noted in its report that lockdowns in several Chinese cities have halted some customers’ spending plans for AI and related product rollouts, and slowed the company’s own smart city projects. As it happened, he decided to redirect its growth objective to smart living and smart automobiles, which tend to be more concentrated in the private sector, and will drive more aggressively in these two segments in the second half of the year.

Among its four business segments, revenue from SenseTime’s smart business unit fell 12.2% year-on-year in the first half of 2022. Revenue from its smart city unit plunged 44.8%, creating the biggest brake on overall turnover. Its smaller smart life and smart auto businesses both performed much better, with growth of 97.6% and 71.1%, respectively. But this combined pair contributed less than 30% of the company’s total revenue.

Increase in provisions for impairment

Shutdowns and other control measures in several Chinese cities in the first half of the year not only delayed the construction of smart city projects, but also prompted smart business customers to delay their AI-related spending. Late payments from these customers increased SenseTime’s receivables due in 6 months to 1 year and 1 year to 2 years by more than 2 billion yuan. In anticipation that some of them won’t make their payments, the company has made 1.5 billion yuan in impairment provisions, up more than half from those a year earlier.

Despite higher cash losses and impairment provisions, the company’s successful IPO last year meant it was still sitting on 19.51 billion yuan in cash, deposits, structured deposits and fixed income bonds. the end of June.

But while a cash crunch isn’t imminent, another major problem remains in the form of Western sanctions. As the two examples we mentioned earlier illustrate, SenseTime has become a “target company” for Washington due to its business of supplying central and local governments with its powerful surveillance technology.

As of October 2019, American companies were banned from doing business with the Beijing unit of SenseTime. Washington then forced SenseTime to completely revamped its Hong Kong listing plan last year when it barred U.S. investors from participating in the IPO. The company came to market anyway and was listed in Hong Kong at the end of December, with 1.5 billion shares issuedat HK$3.85, raising around HK$5.9 billion ($756 million).

Reflecting continued pressure from Washington, SenseTime suffered another blow last week when the United States also banned Nvidia NVDA and AMD AMD to sell their most advanced AI chips to all Chinese customers.

SenseTime’s interim results did not address the latest impact of US sanctions on its business. But revenue from its overseas business reached 19 percent of the total, up 7.6 percentage points from the level for the whole of last year. But the change likely reflects declining revenue in China, rather than indicating that the company’s overseas operations are somehow free from the influence of US sanctions.

Shares of SenseTime have been steadily declining this year after peaking at HK$9.70 in January, falling to HK$2.04 on June 29, nearly half of their issue price. Last Friday, the stock closed at HK$2.26, giving it a market value of HK$76 billion.

SenseTime is trading at a relatively low price-to-sales (P/S) ratio of just 4.2x, less than half of CloudWalk Technology’s 10.79x. This could reflect worries about SenseTime being sanctioned by Washington, as well as investor worries about its heavy R&D spending.

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