Kingsoft Cloud Gets Pelted by Storm Over Locked Novel

Shares of China’s largest independent cloud services provider fell 12% after a social media storm erupted over a novelist who lost access to her work

Key Takeaways:

  • Kingsoft Cloud’s shares fell after it stopped an author from accessing her novel saved on its platform on suspicion she may have violated Chinese law
  • The cloud services provider’s shares have lost three-quarters of their value this year on concerns about U.S.-China tensions and the company’s slowing growth

By Doug Young

This was one story that software maker Kingsoft Cloud (KC.US) probably didn’t want to tell.

Shares of the company, which bills itself as China’s largest independent cloud services provider, took a beating over the last few days after Kingsoft Cloud found itself at the center of a storm on Chinese social media. The matter involved China’s strict laws that require all internet companies to monitor their sites for sensitive content and delete it when they find it.

The story highlights a relatively unique risk to any internet-related company operating in China, be it local names like Kingsoft Cloud and Alibaba (BABA.US; 9988.HK) or foreign giants like Apple (AAPL.US) and Amazon (AMZN.US). Truth be told, none of these companies is really guilty of any unscrupulous practices when they delete such content, and consistently point out that they are only following Chinese law.

But even if that’s true, the negative publicity in such cases doesn’t help, especially in an extremely crowded internet market like China’s where thousands of companies vie for a large but still limited pool of internet users.

The story began on June 25 when a writer who uses the online name Mitu discovered she was locked out of the novel she had been writing on popular word processing software developed by Kingsoft Corp. (3888.HK), parent of Kingsoft Cloud. Mitu told her story online, and it went viral on July 11 when some influencers started talking about it.

Media reports said that Kingsoft Corp. put out a statement saying the file was locked on suspicion that it violated the law. There was no comment from Kingsoft Cloud on the matter. But in all likelihood the file – which the woman has been unable to retrieve – was being hosted on cloud services provided by Kingsoft Cloud.

Some internet users on social media came to Kingsoft’s defense, saying the company was only doing what every Chinese internet company is required to do by law. But the damage was already done.

Kingsoft Cloud’s stock fell 12% on July 11 after influencers picked up the story, and the stock has lost nearly 20% of its value so far this month – wiping out almost $200 million in market value. The declines extended a downward skid for Kingsoft Cloud’s stock that has seen it lose three-quarters of its value since the start of this year.

In a somewhat symbolic development, the company’s market cap fell below the $1 billion mark in the latest selloff to $925 million, making the latest scandal a “unicorn killer.”

Investors were already spurning the money-losing company even before the latest embarrassment. Kingsoft Cloud currently trades at miniscule price-to-sales (P/S) and price-to-book (P/B) ratios of about 0.6. Both of those are well below another cloud services provider, Ming Yuan Cloud (0909.HK), which trades at a P/S ratio of 5.8 and a P/S of 2.2. Even the scandal-tainted Cloopen (RAAS.US), which in May disclosed it was investigating potential customer transaction irregularities at the company, trades at a higher P/S of 1.1, though its P/B ratio is lower at 0.37.

Slowing revenue growth

So, what exactly has investors so spooked about a company that seems quite full of potential?

There doesn’t seem to be any one answer, but instead the plunge in the company’s shares appears to owe to a confluence of several factors. Kingsoft’s stock plunged 48% in a single trading day in March after the U.S. securities regulator started turning up the volume in its threats to delist Chinese companies from U.S. stock exchanges unless it could gain access to their auditors’ work papers. China bans auditors of its companies from handing over those working papers to foreign governments, saying such information is “state secrets.”

The U.S. and Chinese securities regulators are currently in talks for an information-sharing agreement to address the issue, though the U.S. Securities and Exchange Commission (SEC) has cautioned recently that time is quickly running out before a deadline mandated by U.S. law.

While Kingsoft Cloud wasn’t singled out for delisting risk by the SEC at the time in March, investors punished its shares more than most other U.S.-listed Chinese companies. The company later said it was exploring a second listing in Hong Kong, in a move many Chinese companies are making recently, in part to mitigate the risk of their shares becoming untradeable if the SEC delists them.

Then there’s Kingsoft Cloud’s actual performance, which looks slightly problematic due to slowing revenue growth – something investors don’t tend to like in this type of company whose rapid growth is often its main attraction.

The company’s latest quarterly report shows its revenue grew 20% in this year’s first quarter to 2.2 billion yuan ($326 million), representing a sharp slowdown from the 38% growth for all of 2021.

Perhaps most worrisome, the company’s revenue from public cloud services – which account for two-thirds of the total and probably includes the kinds of service being used by the novelist whose document was locked – was flat during the quarter compared with a year earlier. Public cloud services revenue had grown 19.2% in all of 2021. Given current trends and negative publicity from the recent scandal, it’s quite possible the company’s core public cloud services revenue could actually decline in the second quarter from a year earlier.

Kingsoft Cloud’s enterprise cloud services, which make up most of the rest of its revenue pie, grew 89% during the quarter to 793 million yuan. But even that was down significantly from the 111% growth for that category in all of 2021.

At the end of the day, the broader trends certainly don’t look too encouraging for Kingsoft Cloud. But at the same time, the huge drop in the company’s value since the start of the year seems just a tad overblown, and the stock could offer some value for investors with a strong appetite for risk – especially if the U.S. and China reach an information-sharing agreement, and as negative fallout from the latest scandal starts to fade.

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