36Kr Holdings Files For IPO In A Challenging Market – 36KR Holdings (Pending:KRHO)

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Quick Take

36Kr Holdings (KRHO) has filed to raise gross proceeds of up to $100 million from a U.S. IPO, according to an F-1 registration statement.

The firm provides business services to emerging companies in China.

KRHO is growing its top-line revenue, but producing negative operating results amid a volatile U.S. stock market and difficult IPO environment.

I’ll provide a final opinion when we learn more about the IPO from management.

Company & Technology

Beijing, China-based 36Kr was founded in 2010 to provide business services to Chinese companies serving the Internet, hardware and software technologies, consumer and retail and finance industries, which the company refers to as the “New Economy”.

Management is headed by CEO Dagang Feng, who has been with the firm since 2019 and is also the CEO of Beijing Duoke.

36Kr has developed a suite of business services that includes tailored online advertising and subscription services, as well as other enterprise value-added services.

The firm also provides services that help investors identify promising targets, source investment opportunities and connect with startups directly.

36Kr has developed a database covering over 800,000 enterprises, through which it is able to gain valuable insights into the New Economy by using data analysis on user and customer preferences and provide tailored services.

Below is an overview graphic of the company’s business model:

  1. Page Views – during the 12-month period ended June 30, 2019.

Source: Company registration statement

Management says that as of the end of 2018, the company provided business services to 23 of the Global Fortune 100 companies and to 59 of the Top 100 “New Economy” companies in China as measured by market capitalization and valuation, according to a 2019 China Insights Consultancy (CIC) report.

Additionally, since the launch of its institutional investors subscription services in Q1 2017, 36Kr has already covered 46 of the Top 200 institutional investors in China as of the end of 2018, as measured by assets under management, according to the CIC report.

Investors in 36Kr included China Merchants Capital, Ant Financial, Matrix Partners, Infinity Ventures, and e.ventures. Source: Crunchbase

Customer Acquisition

The firm markets its solutions through an in-house sales team that consist of 217 employees as of the end of June 2019, with knowledge and expertise of the New Economy sector.

They are tasked with understanding 36Kr’s customers’ needs as well as to maintain a close relationship with them by providing support and customer services during the course of services.

Sales and marketing expenses as a percentage of revenue have been uneven, per the table below:

Sales & Marketing

Expenses vs. Revenue

Period

Percentage

To June 30, 2019

24.7%

2018

22.4%

2017

26.8%

Source: Company registration statement

The sales & marketing efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of sales & marketing spend, was stable in the most recent period, as shown in the table below:

Sales & Marketing

Efficiency Rate

Period

Multiple

To June 30, 2019

2.6

2018

2.6

Source: Company registration statement

Market

According to a 2018 market research report by IBIS World, the IT services market in China had reached a total revenue of $159 billion in 2018, an increase of 6.2% year over year.

This represents a CAGR of 7.7% between 2013 and 2018.

36Kr operates in the business services subset of the IT services market.

The main factors driving forecast market growth is the increase in IT investments and the growth of China’s information sector.

The China IT services market accounts for about 20% of China’s total IT investment as compared to an average 40% share in other developed countries.

Financial Performance

KRHO’s recent financial results can be summarized as follows:

  • High and accelerating top-line revenue growth

  • Uneven gross profit and gross margin

  • A swing to operating loss

  • Increased cash used in operations

Below are relevant financial metrics derived from the firm’s registration statement:

Total Revenue

Period

Total Revenue

% Variance vs. Prior

To June 30, 2019

$ 29,406,000

176.1%

2018

$ 43,567,000

142.2%

2017

$ 17,986,000

Gross Profit (Loss)

Period

Gross Profit (Loss)

% Variance vs. Prior

To June 30, 2019

$ 9,287,000

159.0%

2018

$ 23,128,000

159.3%

2017

$ 8,919,000

Gross Margin

Period

Gross Margin

To June 30, 2019

31.58%

2018

53.09%

2017

49.59%

Operating Profit (Loss)

Period

Operating Profit (Loss)

Operating Margin

To June 30, 2019

$ (7,272,000)

-24.7%

2018

$ 6,641,000

15.2%

2017

$ 1,643,000

9.1%

Net Income (Loss)

Period

Net Income (Loss)

To June 30, 2019

$ (6,627,000)

2018

$ 5,902,000

2017

$ 1,182,000

Cash Flow From Operations

Period

Cash Flow From Operations

To June 30, 2019

$ (13,822,000)

2018

$ (6,643,000)

2017

$ (1,708)

Source: Company registration statement

As of June 30, 2019, the company had $15.2 million in cash and $15.7 million in total liabilities. (Unaudited, interim)

Free cash flow during the 12 months ended June 30, 2019, was a negative ($22.6 million).

IPO Details

KRHO has filed to raise $100 million in gross proceeds from an IPO of ADSs representing underlying Class A shares.

Class A shareholders will be entitled to one vote, and the co-founders, who will hold Class B shares, will be entitled to 25 votes per share.

The S&P 500 Index no longer admits firms with multiple classes of stock into its index.

Per the firm’s latest filing, the firm plans to use the net proceeds from the IPO as follows:

Approximately 20% to further enhance our content offerings;

approximately 40% to expand our business service scope, client base and service depth;

approximately 15% to improve our data analytics and technological capabilities; and

approximately 25% to supplement our working capital and achieve other general corporate purposes.

Management’s presentation of the company roadshow is not available.

Listed underwriters of the IPO are Credit Suisse and CICC.

Commentary

KRHO is attempting to raise expansion capital from U.S. investors at a difficult time for Chinese companies on U.S. markets.

Trade tensions between the U.S. and China remain unresolved, and U.S. market regulators appear to be increasing their scrutiny of Chinese firms wishing to list their shares.

Furthermore, many Chinese IPOs have performed poorly leading to long investor skepticism about the potential for upside in the near term.

KRHO’s financials show a firm that is growing rapidly and at an accelerating rate.

However, the firm is producing operating losses and has swung to negative cash flow, leading me to wonder if the domestic Chinese economy is weighing on the firm’s results.

Sales and marketing expenses as a percentage of revenue have been uneven as the firm has scaled operations.

The IT services market opportunity for the firm is large and growing as Chinese companies seek improved IT infrastructure to maintain competitiveness despite increasing labor costs in China.

On the legal side, like many Chinese firms seeking to tap U.S. markets, the firm operates within a VIE structure or Variable Interest Entity. U.S. investors would only have an interest in an offshore firm with contractual rights to the firm’s operational results but would not own the underlying assets.

This is a legal gray area that brings the risk of management changing the terms of the contractual agreement or the Chinese government altering the legality of such arrangements. Prospective investors in the IPO would need to factor in this important structural uncertainty.

Given overall U.S. stock market volatility weighing on the IPO market, I’m not optimistic about KRHO’s prospects in the near term.

I’ll provide an update when we learn more details from management about the IPO.

Expected IPO Pricing Date: To be announced.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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