Here we highlight how the company – with its focus on private cloud services – endures and stays relevant in a hybrid cloud world, as well as how its strategy affects short-term earnings.
QingCloud is the second-place cloud stock on Shanghai’s Star market. Following in the footsteps of its peer, the number-one cloud computing stock UCloud, QingCloud filed for a CNY 1.2 billion (USD 167 million) Initial Public Offering (IPO) last week.
QingCloud is attempting to differentiate itself from the present hype around cloud computing in China, where dozens of domestic competitors (Alibaba Cloud, Baidu Cloud, Kingsoft Cloud, JD Cloud) as well as overseas names like AWS and Microsoft Azure, are jockeying for position.
Investment thesis
A secular bull in the niche. Due to the coronavirus outbreak, Chinese cloud computing concept stocks had seen a rise of 17% over the foregoing 120 trading days as of April 9, 2020. China's private cloud market is expected to grow to CNY 1.2 billion at a four-year 22% Compound Annual Growth Rate (CAGR) in 2022, while the public cloud will reach CNY 1.7 billion at a compound 41% increase, according to CAICT.
Selling the PaaS products and the core AppCenter buildup. The ecosystem will be a crucial driver to boost revenue and win in the next half stage of the competition. QingCloud differentiates itself from AppCenter. Chinese Infrastructure-as-a-Service (IaaS) vendors remain strong in products with less gross margins (say, virtual machines (VMs) and storage). Some development services vital for enterprise adoption – Business Analytics (BA), Internet of Things (IoT), Artificial Intelligence (AI) – are still lagging behind foreign peers. QingCloud's efforts in adding more SaaS products will build a fertile base.
Hybrid cloud is the new norm and thus, multi-cloud management capacity embraces high growth. We see the company's strategy as being to bet big on the private cloud and make meaningful infrastructure moves to drive future business growth.
Trends are appearing in the hybrid cloud world: those who are permeating into a broader customer base are becoming the new leaders. The penetration in Internet enterprises will be less meaningful as cloud migration become dominant across all industries. The non-Internet field – governments, telecoms, finance, manufacturing, gas & oil, education and healthcare – should become the new battlefield. Though more fortune 500 companies are utilizing public cloud services as public cloud vendors keep improving their offerings' cost-efficiency and the cloud accelerates decision-making processes, the speed might come at the cost of security. Chinese large enterprises are staying in private or hybrid cloud environments to avoid making this kind of trade-off. (Read more about cloud migrants on EqualOcean about Enterprise Services – Trends and Startups 2019)
QingCloud's core competitiveness lies in the ability to build a full-stack cloud development platform, with a healthy obsession for decoupling that allows enterprises to build parts of their business on its platform.
Key risks
Infrastructure IT providers like QingCloud could see a demand deceleration in 2020.
Rising competition leads to a longer timeline towards profitability. Most QingCloud private cloud customers come from banks, insurance companies and securities, while public cloud customers come from e-commerce. Ping An Technology's comprehensive solutions in insurance make the firm a strong competitor in the niche; category leaders Alibaba Cloud and JD Cloud's experiences in e-commerce pose challenges for QingCloud's industry penetration as well.
The company may be unable to monetize PaaS products as expected.
Key takeaways
QingCloud is investing in underlying network infrastructure – including SD-WAN (software-defined networking in a wide area network) and backbone networks – which play an essential role in cutting by more 20% of costs for public cloud services.
Bandwidth and data centers are two dominant components in the cost. With the improvement of the backbone network, the company can move data centers from Beijing and Shanghai to lower-tier cities like Wuhan and Xi'an to save rents and electric bills.
Cloud migrants admire how IaaS automates the management of traditional IT operations; likewise, given the rising complexity of managing multiple environments, more CTOs want better orchestration tools. Thus, QingCloud developed middleware products – ranging from Cloud Foundry to Docker, Kubernetes and Mesos.
These orchestration tools became the base of AppCenter, which helps transform cloud services from being resource-centered towards being app-centered. They also create an entrance for the firm to interact with millions of Software-as-a-Service (SaaS) users and build an enterprise cloud ecosystem by providing a set of APIs for partners to improve collaboration.
"Think of how Microsoft utilizes windows and you can imagine how we utilize AppCenter. Just like Microsoft opens its system for applications like QQ and Chrome, we open the development architecture AppCenter to our partners," the company founder, Richard Huang (Huang Yunsong), said recently in an interview.
While the company has a clear path to profitability from the perspective of the product mix, the financial reports tell another story.
The economics of scale and network effects are yet to be realized. When QingCloud grew its sales to CNY 377 million in 2019, a 57% increase from two years ago, the cost of goods sold rose by 77% to CNY 330 million. Meanwhile, the net losses widened to CNY 191 million, a 98% increase compared with 2017. Cloud products – private cloud offerings – accounted for about two-thirds of total revenues in 2019. 
Costs are rising as the company delivers more hardware accelerators such as HCI – a system that takes multiple physical computers and binds their internal storage into shared storage, useful for virtualization and Software-Defined-Storage (SDS) products. Hardware costs took up 66%, 68% and 88% of COGS in 2017, 2018 and 2019, respectively.
Selling to large enterprises takes a lot more energy as well, besides higher Customer Acquisition Costs (CACs). To fill the customized needs while keeping the focus on cloud architecture, the company will outsource non-core elements and applications to third-parties, adding more expenses for the firm to deal with.
On the other hand, the relatively small public cloud user base cannot offset the cost driven by the heavy traffic in data centers and facility improvement. Together, the data centers, depreciation and amortization account for 83% of revenues in its public cloud business (aka ‘cloud services,’ as named by the company). Overseas peers like VMware (VMW:NYSE), Nutanix and Red Hat can deliver higher gross margins due to zero hardware costs (around 85%).
The overheated public cloud market also saw price wars spreading, which have impacted the company's top line. In 2019, for instance, majors players cut down prices by 20%-50% to vie for higher market shares. The competition will persist and the price will keep going down to meet the marginal cost, as the cloud industry matures.