Yonyou reported (28 Oct) mixed 3Q23 results: revenue was RMB2.3bn (+14 % YoY), in line with Bloomberg consensus estimates, and demonstrated an improvement from -5% YoY decline in 1H23, thanks to the gradual wear off of reorganizational impact. 3Q23 net loss attributable to ordinary shareholders was RMB185mn; although it narrowed from that of RMB284mn in 3Q22, it missed consensus of a loss of RMB138mn, which we attribute to the 4.3ppt miss on GPM, which came in at 50.9% (3Q22: 49.9%). We upgrade the stock from SELL to HOLD given likely better outlook on revenue growth and margin improvement in 4Q23 with the wear off of reorganizational impact, but overall macro and enterprises’ budget pressure takes time to relieve, and we await more concrete evidence to become more positive. Our TP of RMB16.45 is based on 5.5x EV/Sales (was 6.0x) on 2023E revenue, in line with the one-year mean.

Inflection point on cloud revenue growth appeared…In 3Q23, cloud

services revenue was RMB1.6bn, up 28% YoY (1H23: 2.0% YoY) and ERP revenue fell 10% YoY to RMB713mn. Cloud service revenue for large /mid- sized enterprise came in at RMB1.1bn/162mn for 3Q23, with respective growth of 22%/61% YoY, improving from -3%/+25% YoY in 1H23.

Management highlighted that new contract value growth was over 20% YoY each month for four consecutive months since June 2023 vs. -6% YoY in 5M23, and cumulative contract value for large enterprises reached RMB3.0bn/1.27bn in 9M23/3Q23, up 17/29% YoY, which both demonstrated an improvement in fundamentals, in our view.

but concrete margin improvement likely takes time. GPM improved

1.0ppt to 50.9% in 3Q23, driven by healthy revenue growth, but was 4.3ppts shy of consensus forecast due to greater-than-expected impact from organizational change (especially for large enterprise projects). As for operating expenses, S&M expenses grew 20% YoY in 9M23 (30.3% of total revenue, +4.7ppts YoY), administrative expenses up 1% YoY in 9M23 (14.0% of revenue, -0.2ppt YoY), and R&D expenses grew 1% YoY in 9M23 (26.2% of total revenue, -0.3ppt YoY). We estimate ARR contribution for cloud revenue to be stable YoY at around 32% for Yonyou (vs. >60% for Kingdee) in 2023, and we believe an increase in ARR contribution is vital to drive the unleash of operating leverage over the long term.

Cut target price to RMB16.45 but upgrade to HOLD. Yonyou’s share price

has fallen 33% vs. -8% for CSI300 YTD, and we believe the market has priced in the impact of the organizational changes. With a better revenue growth outlook compared with that in 1H23, further downside on stock price could be limited, but recovery on macro and enterprises’ digitalization budget likely still takes time to bring concrete improvement on Youyou’s top-line growth, and we await more concrete evidence to become more positive.