With Fast Growth but Bumpy Profits, Xuan Wu Cloud Poised for IPO Lift-off

The intelligent CRM services provider expanded on the back of China’s retail revolution and has now passed its IPO hearing with the Hong Kong Stock Exchange

Key Takeaways:

  • Xuan Wu Cloud, a CRM supplier with rising revenues and high client retention rates, gained IPO approval from the Hong Kong Stock Exchange
  • The company’s net profits have been volatile and gross margins have fallen, as a major part of its revenue derives from the low-margin platform business

By Lau Ming

For some companies, unpredictable business conditions can clearly be an opportunity as well as a challenge. Take, for example, China’s growth market in the digital tools that help firms manage their customer relationships and identify sales leads more efficiently.

Providers of these intelligent customer relationship management (CRM) services have enjoyed rapid expansion, with the biggest global CRM software supplier Salesforce (CRM.US) averaging annual growth of between 20% and 30% for more than decade, earning it a place as a component stock in the Dow Jones index.

In China, domestic CRM service providers are jostling to challenge Salesforce for market dominance, and Xuan Wu Cloud Technology Holdings Ltd., as the biggest of the Chinese intelligent CRM brands, is looking to pull ahead using funds from an IPO on the Hong Kong Stock Exchange.

The company passed its IPO hearing on Monday and is poised to start the public offering process soon, giving investors the chance to hop on the Chinese CRM bandwagon.

Demand for intelligent CRM services has spiked across Chinese industries in recent years with the rise of the industrial internet and retail transformations, as well as the challenges of managing business operations through the pandemic.  And Xuan Wu Cloud has emerged as an industry leader in just 12 years.

The Chinese market for intelligent CRM grew from around 25 billion yuan ($3.75 billion) in 2017 to just under 72 billion yuan in 2021, using a measure called total addressable market (TAM) value, according to an industry report cited in the company’s IPO prospectus. That equates to a compound annual growth rate of around 30%, with the market value projected to rise to 280 billion yuan by 2026.

Revenue-wise, Xuan Wu Cloud claimed nearly 14% of this growing pie last year as the second biggest intelligent CRM service provider, closely behind first-ranked Salesforce with a market share of 18%.

High retention rates

Companies grappling with pandemic measures and looking to speed up their digital transition have been increasingly reaching for CRM tools. Up to 60% of the pandemic-hit companies that restored their business operations in just three months are in general digitally proficient, according to data from the China Association for Small & Medium Commercial Enterprises.

So, the intelligent CRM sector looks to be entering a development fast lane, with Xuan Wu Cloud hoping to reap rewards as an industry leader.

One of its strengths lies in a strong client base. Many leading companies in big and booming sectors such as fast consumer goods, financial services and digital new media are among its customers. In its prospectus, the company said it provided services to 28 of the top 100 Chinese food companies and 24 of the top beverage companies as well as 20 top-100 grocery brands and 10 top-100 alcohol brands.

It also served 37 of the top 100 banks in the financial sector and 21 of the leading 100 Internet companies as well as 15 top-100 software companies in the digital new media sector. This customer base provides a launchpad for Xuan Wu Cloud to benefit from further CRM expansion in China.

Moreover, it can boast strong credentials for client retention. Its net dollar retention rate, a metric for revenue from established customers, ranged between just under 100% and around 113% in the past three years. These clients contributed more than 90% of its revenue, indicating that the company is managing to retain customers and gain more revenue from them.

Its CRM services fall mainly into two categories: CRM Platform as a Service (PaaS) and CRM Software as a Service (SaaS). It charges customers for usage and subscriptions, as well as levying execution and servicing fees. High retention rates have thus become a foundation for sustained revenue growth, though profits have been bumpy.

Its revenue has risen consistently, reaching 991 million yuan last year compared with 518 million yuan in 2018.  But its net profit fell nearly 48% last year to just 14.51 million yuan. Its total gross margins, an indicator of profitability, were also on a downward trajectory, from nearly 33% in 2019 to just over 24% in 2020 and 23% in 2021.

The company said profitability was squeezed because the lower-margin PaaS business accounted for the lion’s share of its total revenue. In fact, margins on its SaaS operation were approaching 40% in the past three years, compared to margins of around 11% to 25% from PaaS. But the PaaS platform business, with higher operating costs, is growing faster than the SaaS software side.

Rising sales costs

The company also acknowledged that sales costs have been outpacing revenue in recent years. It cited big cost increases for telecoms access and services, which cancelled out benefits from lower spending on distribution and R&D as a share of revenue.

The Chinese intelligent CRM service industry is highly concentrated with the top five players accounting for 63% of revenue in 2021. In terms of market share, Xuan Wu Cloud has only a narrow edge on its Chinese rivals.  That means contenders for market supremacy must invest to gain a competitive advantage and to keep up with consumer demands, but without passing the burden of rising costs onto customers.

Given all this, the company plans to use its IPO funds to strengthen its technological infrastructure and R&D capacity in areas including AI and data intelligence, as well as expanding its talent pool and services. It expects its R&D expenses and capital spending to increase, weighing on margins.

However, investors tend to favor CRM software providers over other software companies, according to a report from consultancy iResearch, with a stronger preference for fast-growing or mature CRM brands.

Such a trend would bode well for Xuan Wu Cloud’s IPO.

In terms of valuations, Kingdee International (0268.HK), a software provider with a comprehensive portfolio, reported losses in the past two years with latest price-to-sales (P/S) ratio of 9.9 times, while Kingsoft (3888.HK) and Salesforce have lower P/S ratios of 4.6 times and 6 times respectively. Based on an average ratio of 6.8 times from the three industry peers, Xuan Wu Cloud could expect an IPO valuation of HK$8 billion ($10.3 billion).

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