Event: The company released its 3Q23 results, achieving revenue of 1.63 billion yuan, a year-over-year decrease of 17.5%/11.5%, mainly due to the company continuing to actively reduce the scale of the CDN business and gradually eliminate loss-making customers; gross margin continued to increase for five consecutive quarters, 3Q23 reached a record high of 12.1%, and a year-over/month-on-month increase of 5.9pcts/0.8pcts, mainly benefiting from public cloud business revenue structure optimization, industry cloud project quality improvement and effective cost control. In 3Q23, net loss was 790 million yuan, and adjusted net loss was 3.1 billion yuan. The median difference was mainly due to the company's long-term asset impairment.

The public cloud CDN business continues to shrink. Xiaomi has become the company's largest customer, and AI revenue may be further released in 2024. 3Q23's public cloud revenue reached 1.02 billion yuan, a year-on-year decrease of 24.5%. Mainly due to the company continuing to reduce the scale of the CDN business and optimize the customer structure, 3Q23's largest CDN customer revenue share has fallen from 16% in 2Q23 to 12%. On the profit side, 3Q23 public cloud gross margin increased from -1.6% in 3Q22 to 4.7%, mainly benefiting from improvements in revenue and customer structure. The company continues to deepen strategic cooperation with Xiaomi & Jinshan. In 3Q23, Xiaomi & Jinshan Ecology accounted for 17% of total revenue. Among them, Xiaomi has become the company's largest customer. Driven by the WPS AI business, the revenue of the Jinshan office in September increased by nearly 50% compared to January. In terms of AI, the company is optimistic about AI opportunities and continues to enhance its own research capabilities: 1) launch mutual trust VPC for large model application scenarios; 2) serve Himalayan voice model training scenarios; 3) independently develop core technologies such as the Embedding model, multiple recall algorithms, and intelligent data slicing models, and build a knowledge assistant for Jinshan Cloud Qingzhou. The company invested 415 million yuan in AI-related CapEx in 3Q23. This scale has exceeded the sum of the three quarters of 4Q22-2Q23; at the same time, AI business revenue has shown a rapid growth trend. 3Q23 AI revenue has increased by more than 70% month-on-month. We expect that with the company's continued investment in CapEx and the increase in domestic computing power performance and production capacity, the company's AI revenue contribution will gradually ease the shortage of AI computing power, and the company's AI revenue contribution is expected to be further released in 2024.

The industry cloud focuses on improving efficiency and continues to expand benchmarking experience. In 3Q23, the company's industry cloud achieved revenue of 61 billion yuan, a year-on-year decline of 2.2%, mainly due to the company's higher screening criteria, reduced project scale, but focused more on selecting vertical industries and high-quality projects, driving gross margin to 24.2% from 23.1% in 3Q22. By business: 1) Colette's business performance is solid. On the basis of maintaining stable cooperation with existing major customers, 5 new customers were signed this quarter, and profit margin levels rose steadily; 2) In terms of its own industry cloud, the company continued to focus on the three vertical fields of public service, healthcare, and financial services, and upgraded the Galaxy platform's “one cloud multi-core” capability (compatible with platforms such as Intel, Kunpeng, Haiguang, Longxin, etc.) to provide industry customers with localized enterprise-grade hybrid cloud solutions. In the future, the company is expected to re-promote high-quality projects, achieve a virtuous cycle, and drive a steady increase in profitability.

Profit forecast, valuation and rating: Considering that the company's long-term asset impairment exceeded expectations, we lowered the net profit of the company by 26% in '23 to -2.52 billion yuan. However, it is expected that with customer structure optimization, AI revenue share increase, and cost reduction and efficiency improvements continue to advance, the company's net loss is expected to continue to narrow, increasing net profit by 3%/12% to -18.0/-1.44 billion yuan in 24-25, maintaining the company's “increased holdings” rating.

Risk warning: Increased competition in the cloud industry, industry cloud expansion falling short of expectations, AI progress falling short of expectations, etc.