Can the Dreamlike Kling help Kuaishou escape the 'e-commerce valuation'?

$KUAISHOU-W(01024.HK) released its second-quarter report after the Hong Kong stock market closed on August 21, Beijing time. Recently, Kuaishou's stock price performance has been a hot topic in the Hong Kong stock market, with the major contributor being Kling. Although Kling's contribution to the group's profit is not significant, the shift in sentiment has gradually moved Kuaishou's valuation from a 10x e-commerce valuation towards a 15x "platform & technology" valuation.

So how did the traditional main business perform outside of Kling? Let's take a closer look at the second-quarter results:

Specifically:

1. User Ecosystem Stability: The second quarter saw 715 million monthly active users, a net increase of 3 million from the previous quarter. Looking at promotional expenses, growth continues to be slow. Based on data from third-party platforms, Kuaishou's overall traffic is relatively stable, with no significant growth or sharp decline.

The company's key daily active user metric was 409 million in the second quarter, maintaining a user stickiness (DAU/MAU) of 57%.

2. E-commerce Slightly Exceeds Expectations: Although the 618 shopping festival was not particularly strong in the second quarter, and Kuaishou's initial guidance was not high, the actual performance was satisfactory. GMV grew nearly 18% year-on-year, exceeding the initial low double-digit guidance and market expectations, mainly driven by an increase in average spending per user, which grew approximately 15% year-on-year.

During the 618 period, with specific activities, the proportion of general merchandise e-commerce increased to 32%, with daily active merchants in mall scenarios growing 30% year-on-year. Ultimately, with little change in commission rates, overall e-commerce service revenue (excluding Kling revenue) exceeded expectations with a 20% growth, surpassing the market expectation of 15%.

3. Advertising Recovery Disrupted: Advertising growth was 12% in the second quarter, showing a recovery trend compared to the first quarter. However, due to payment issues in Brazil and the impact of the food delivery battle (platform advertising budgets replaced by user subsidies), the recovery pace slowed compared to previous expectations (growth rate adjusted down by about 3-5 percentage points).

Kuaishou's response was to join the battle, partnering with Meituan to enhance the food delivery entry level, which may benefit advertising in the second half of the year. However, there is no need to be overly optimistic, as Kuaishou's food delivery transaction chain involves an additional step of redeeming codes, slightly affecting actual conversion rates. But given the management's past style, we expect the guidance to have some leeway.

4. Kling's Full-Year Target Raised: Second-quarter revenue was 250 million, and after raising the target to $100 million last quarter, this quarter it was further increased to $125 million (approximately 900 million RMB). Kling's impressive performance is due to the release of version 2.0. Although major companies have subsequently released new versions of video large models, Kling remains in a strong development phase due to its advantages in front-end functionality, ecosystem completeness, and cost-effectiveness.

However, for some aggressive funds, this guidance may not be satisfactory. Before the financial report, the market had already expressed dissatisfaction with the July revenue growth by suppressing the stock price. This guidance increase may have already been digested in this process.

5. Live Streaming Slightly Exceeds Expectations: Growth was 8% in the second quarter, exceeding the market expectation of 5%. Over the past year, during the rectification period, Kuaishou has continued to expand the scale of guilds, signing more quality streamers, especially focusing on expanding the game live streaming field.

6. Operating Efficiency Continues to Improve: Although in absolute terms, operating expenses were basically in line with expectations, considering the revenue exceeded expectations, actual operating efficiency improved. Ultimately, the core main business operating profit was 4.7 billion, nearly 400 million higher than expected, mainly contributed by the revenue exceeding expectations. The core operating profit margin was 13.4%, with a long-term potential to approach 15%~20%.

7. First Surprise Dividend: Kuaishou's second-quarter performance slightly improved year-on-year, but there was still a further slowdown quarter-on-quarter. A total of less than 700 million HKD was spent to repurchase 14.6 million company shares at an average price of 50 HKD.

However, the surprise is that, in addition to the normal repurchase, a first special dividend totaling 2 billion HKD (0.46 HKD/share) was announced, expected to be distributed in October. As a result, this year's repurchase + dividend totals about 7.5 billion HKD, corresponding to the current market value of 310 billion HKD, with a shareholder return rate of about 2.5%. This means that despite the significant increase in market value in the second quarter, the shareholder return rate remains at the same level as the previous quarter.

8. Detailed Financial Report Data

Dolphin Research's View

The second-quarter performance was actually quite good, especially with e-commerce exceeding expectations. However, the full-year guidance was not raised accordingly, mainly due to the negative impact of Brazil and the food delivery battle on advertising. Additionally, while Kling's outlook was raised, it was not surprising, as aggressive funds had higher expectations and recently adjusted downward.

However, based on past situations, it is not ruled out that the guidance has some leeway, with management deliberately being conservative. Coupled with the stock price having already adjusted for half a month before the financial report, with a 13% decline, it also reflects the attitude of funds taking precautions in advance.

Compared to Dolphin Research's judgment on Kuaishou last quarter:Traffic has peaked, and there is pressure on the growth of the main business, but there is an opportunity to focus on AI speculation under low valuation, guiding the valuation from a 10x P/E "e-commerce valuation" to a 13x P/E "midpoint between 10x e-commerce and 15x social platform valuation".

This time there are two changes:

1. Sustainability of Kling

AI for Kuaishou has gradually become a sustainable business increment from speculation. This means that the current valuation increase is not purely based on sentiment and liquidity, but also has some fundamental support. The significance of this cognitive change is that it can better determine how much valuation premium Kling can bring. For example, looking at Kling's long-term contribution to the group's performance, or when sentiment is positive, calculating a separate valuation for Kling and then adding it to the group.

The reason for the cognitive change is that Kling has withstood competition from giants, partially verifying its own advantages. After the release of Kling 2.0 in May, Douyin Seedance, Alibaba Wan, and Google Veo subsequently released new versions, ranking on par with Kling in the global AI video large model performance rankings. However, Kling seems to maintain its first-mover advantage with its cost-effectiveness and real-time generation on mobile devices (relative advantage overseas), and scenario ecosystem completeness (relative advantage domestically).

This first-mover advantage helps Kling gain brand recognition among more professional user groups, meaning that Kling's future does not need to rely entirely on the Kuaishou ecosystem and can exist as a standalone AI software platform.

As of July, Kling's annualized revenue was about $180 million (short-term revenue is generally 70-80% of income), and mid-August Sensor Tower data showed a decline in Kling's user activity and revenue growth not meeting market optimistic expectations, causing a 7% drop in the market that day, subsequently dragging the stock price into consolidation.

However, it should be noted that Kling's main revenue source—ToB or ToP (Prosumer professional creators)—mainly generates revenue from the PC side, which Sensor Tower cannot monitor. Therefore, attention should be paid to management's explanation of Kling's total user numbers and platform distribution during the conference call for future reference to track ST data.

(2) Resilience in the Main Business

On the other hand, the expectation gap is that the main business has shown more resilience than expected under environmental pressure and intense competition. Especially in the e-commerce business, the continuous penetration of general merchandise e-commerce has begun to provide some support, with the current 32% penetration rate expected to continue rising. In Dolphin Research's view, short video e-commerce and general merchandise e-commerce are healthier e-commerce ecosystems than KOL influencer e-commerce.

In addition, the company guides third-quarter e-commerce GMV growth of 15%, although slowing from Q2, it is slightly higher than the previous low double-digit expectation. This growth pace is consistent with the company's internal target set a year ago, indicating that despite competition and major streamer volatility, Kuaishou's e-commerce has basically entered a steady state, with marginal impact weakening.

In terms of advertising, Q2 saw a recovery. Although Q3 & Q4 guidance was lowered, missing market expectations, Dolphin Research believes the reasons are temporary objective factors rather than subjective competitiveness or ecosystem damage. Clearly, the latter has a greater impact on long-term expectations.

Finally, looking at valuation, the company's 2025 operating target remains unchanged, with revenue growth +12%, adjusted net profit reaching 20 billion, and a profit margin of 14%, growing 13% year-on-year. Dolphin Research tends to believe that management has left some leeway out of caution.

Since Kling's current profitability is low, we recommend valuing the main business and Kling separately: (1) Valuing the main business at 13x forward P/E, assuming 26-year operating profit grows 15% year-on-year to about 24 billion, corresponding to 342 billion HKD; (2) Estimating Kling's valuation at 22 billion HKD based on 20x P/S (for Kling's TAM, institutions estimate $10-25 billion).

In a positive market sentiment, the total of (1) + (2) is 364 billion HKD, with a 13% upside compared to the current 322 billion HKD.

Detailed Analysis Below

I. User Ecosystem Stability: Expansion Stagnation, Retaining High-Stickiness Users

Kuaishou's monthly active users reached 715 million in the second quarter, an increase of 3 million quarter-on-quarter, mainly benefiting from the e-commerce peak season. The average daily time spent per user was 127 minutes, an increase of 5 minutes year-on-year.

Based on third-party data, Kuaishou's user ecosystem is difficult to expand further, especially when compared to Douyin, where it pales in comparison. However, the remaining users have high stickiness, consistently maintaining a 57% DAU/MAU. Therefore, the future strategy is to control expenses (Q2 sales expenses continue to slow down) and moderately advance monetization.

Additionally, Dolphin Research typically calculates the user operation cost indicator (sales expenses + content costs) to assess changes in the proportion of natural traffic. If operation costs rise, it indicates a decline in the platform's new attraction to traffic, requiring more investment to retain users. Conversely, it indicates stable natural traffic on the platform.

This indicator continued to grow in the second quarter, but the growth rate continued to slow. From a marginal perspective, at least at the company level, the overall efficiency of retaining users has improved.

II. E-commerce Exceeds Expectations

Second-quarter e-commerce and other revenue grew 26% year-on-year, with Kling revenue at 250 million, and the full-year target raised to $125 million (9 billion RMB). The remaining e-commerce revenue grew 20%, with GMV growth of 18% and a slight increase in the take rate.

Breaking down GMV into "monthly average paying users" and "average spending per user," second-quarter GMV growth was mainly driven by an increase in average spending per user, which grew approximately 15% year-on-year.

This year, e-commerce competition is not lacking, especially with video accounts making a big push. Dolphin Research originally thought the impact on Kuaishou would be quickly seen in the second quarter, but it was not the case. Meanwhile, Kuaishou's general merchandise GMV proportion increased to 32%, with penetration recovering, and during the 618 period, daily active merchants in mall scenarios grew 30% year-on-year.

Although the trend of general merchandise advancement continues, the pace needs to accelerate. The business model of live streaming e-commerce is not very favorable for the platform, as traffic distribution rights are dispersed among various streamers and MCNs, dragging down traffic monetization efficiency (streamer commissions are high). Additionally, platform operations can be influenced by the personal conduct of major streamers, and if a heavily relied-upon streamer behaves inappropriately, it can be a disaster for the platform.

III. Advertising: Growth Stalls on High Base, Recovery Next Quarter

Second-quarter advertising revenue was 19.8 billion, growing 13% year-on-year, partly due to a slight slowdown in the base and partly benefiting from AI's improvement in advertising conversion efficiency. Specifically, it should mainly be e-commerce for internal circulation advertising and short dramas, games, and other fields for external circulation advertising.

Objectively speaking, the macro environment has not significantly warmed up, so the advertising market outside of e-commerce has not increased much. The main change is structural, such as the increase in short drama placements, which actually erodes the share of long videos.

IV. Live Streaming Slightly Exceeds Expectations, Future Basically Stable

Second-quarter live streaming reward revenue was 10 billion, growing 8% year-on-year, higher than the market expectation of 5%. Dolphin Research believes this is mainly due to Kuaishou's continued active introduction of more quality guilds, with the number of signed guilds growing 20% year-on-year and the number of streamers growing 30%.

On the other hand, Dolphin Research's reverse calculation of the live streaming revenue sharing cost ratio is still higher than the same period last year, representing the dilution brought by high commissions and fixed commissions from streamer guilds.

Other continuously expanding live streaming scenarios (job recruitment, real estate agency) showed significant slowdown in growth in the second quarter:

1) Daily resume submission users for Quick Recruitment grew 40% year-on-year (last quarter's metric was resume count growing 110% year-on-year), with two-way matching scale growing over 150% year-on-year (last quarter 300%);

2) Ideal Home business saw daily search scale grow over 60% year-on-year.

V. Profit Margin Slightly Improves

Kuaishou achieved a GAAP net profit of 4.922 billion in the second quarter, down 24% year-on-year. After adding back SBC and investment gains and losses adjustments, the Non-GAAP net profit was 5.6 billion, growing 16% year-on-year, exceeding market expectations with revenue beat.

However, the adjusted net profit still includes other income unrelated to the main business, such as government subsidies and financial income. If only looking at the main business fundamentals, Dolphin Research generally looks directly at the "core main business operating profit" without any adjustments.

In the second quarter, the core main business operating profit was nearly 4.7 billion, with a profit margin of 13.4%, slightly rising year-on-year. This was mainly because revenue expansion spread out the expenditure, and despite the nearly doubling of management expenses due to overseas business investment, it did not drag down profitability due to its small scale (Kuaishou's main expenditure is in sales expenses).

The growth in sales expenses was mainly due to the increase in personnel teams, with little growth in promotional marketing expenses of 5%. R&D expenses also increased by nearly 20% this quarter, explained by the increase in AI-related R&D personnel.

By Region (Domestic and Overseas), the second quarter saw the overseas platform's advancement still in the Brazilian market, empowering local Brazilian merchants through full-chain digitalization. However, due to payment issues, transaction conversion was affected, which may drag down third-quarter advertising growth. Despite business expansion, through cost and expense control, the second-quarter operating profit remained positive (operating profit margin 1%).