SenseTime reported FY23 financial results on 26 Mar: total revenue declined by 11% YoY to RMB3.4bn in FY23, below consensus estimate of RMB4.3bn, primarily due to the decline in the Traditional AI business as the company shifted its strategic focus to Generative AI business; adjusted net loss widened by 14% YoY to RMB5.4bn in FY23, versus consensus estimate of RMB3.7bn, due to investment in AI infra and impairment loss of RMB1.8bn (mainly for trade receivables of the smart city business). For 2024, the company will further accelerate the monetization of generative AI services, which we expect to support its revenue rebound. Meanwhile, the company will enhance operating efficiency and improve cash flow conversion capability in 2024, via cutting non-core businesses. However, we expect the adjustment of Traditional AI business will drag overall revenue growth in the short term, and thus cut our FY24/25E revenue estimate by 24/24%. Our target price is lowered to HK$1.25 (previous: HK$2.30 based on 13x FY23 EV/sales) based on 7.0x FY24E EV/sales, which is a discount to the average EV/Sales of China's AI peers (7.8x), reflecting SenseTime's Traditional AI business headwind.
Generative AI business recorded strong growth in FY23. Generative AI business revenue grew by 200% YoY to RMB1.18bn, and accounted for 35% of total revenue in FY23 (FY22: 10%), mainly driven by strong demand for model training and fine-tuning services. Over 70% of the Generative AI customers are new customers to SenseTime in FY23, while the average revenue per customer of the remaining 30% also recorded c.50% YoY growth. The consumer-end usage of SenseNova foundation model also saw a c.120-fold increase in FY23. On the other hand, the Traditional AI business revenue was down by 41% YoY to RMB1.84bn in 2023, as the company focused its resources on Generative AI business and scaled back smart city business. Revenue contribution from smart city business declined from 29% in FY22 to less than 10% in FY23. We expect the revenue mix shift to improve the cash conversion and profitability of SenseTime in the long term.
Monetizing generative AI opportunities. Looking into 2024, SenseTime's strategic goals will focus on: 1) maintaining competitive edges in AI technology by further doubling the scale of its computing power (currently at 12,000 petaFLOPs with 45,000 GPUs); 2) accelerating the monetization of Generative AI business; 3) enhancing profitability and cash conversion capability via spinning off non-core businesses. We see SenseTime to benefit from the secular trend of generative AI development, given its robust AI infrastructure and large model capability.
Expect enhancing profitability and cash conversion in FY24E. SenseTime's GPM dropped by 23ppt YoY to 44.1% in 2023, primarily due to investment in AI infrastructure. We expect the GPM to stabilize over FY24-26 as the company accelerates monetization of Generative AI business. We also expect improving adjusted net loss margin from -157% in FY23 to -71/-42% in FY24/25E, as SenseTime continues to enhance its operating efficiency and scale back non-core business.