Investment positives

We initiate coverage of Raycloud Technology (Raycloud) with an OUTPERFORM rating and a target price of Rmb11.00. Raycloud is a frontrunner in the domestic market for e-commerce related software as a service (SaaS) products and solutions. We are upbeat on the growth potential of its large merchant & e-commerce SaaS business and its product portfolio buttressed by its independently developed products and equity investment.

Why an OUTPERFORM rating?

Focusing on the e-commerce service market. Retail sales of products and services at online stores in China increased at a CAGR of 20.4% over 2016-2021 and reached Rmb13trn in 2021. We expect the retail sales to continue to grow steadily. The e-commerce service industry provides infrastructure for e-commerce companies, and e-commerce SaaS are the supporting services for such companies. Data from leadleo.com shows that the size of the market for retail e-commerce SaaS services will likely increase at a CAGR of 30.9% over 2021-2025 and reach Rmb38.5bn in 2025 (vs. Rmb10bn in 2021).

Small- and medium- merchant business is a cash cow; extensive experience, steady growth and strong profitability. SaaS products for small- and medium- merchants were one of the first products at the company. Raycloud now offers a wide range of product categories. Its Express Assistant and Super Shop Manager are popular trading and product management products. The company enjoys the following competitive advantages: A large user base and solid reputation (the number of paying users has reached nearly 400,000 for multiple products), reliability during peak hours, innovative technology and product portfolio, and extensive experience in post-M&A consolidation. The small- and medium- merchant business is a cash cow, in our view, as evidenced by a net profit margin of more than 30%. We expect this business to keep growing steadily, thanks to the firm's multi-platform strategy.

Large merchant business boosts revenue growth; Raycloud to become a platform-based company. The firm began to increase R&D investment in 2018. It has rolled out many e-commerce SaaS products for medium- and large- merchants (such as Kuaimai Enterprise Source Planning (EPS) and Kaimai Design), and acquired Deepdraw to win key account (KA) customers. In addition, the company has built an offline direct-sales team. We believe the large merchant business will become a key revenue growth engine for the firm. Raycloud is continuing to strengthen its product portfolio & service ecosystem and enhance its capability to offer integrated solutions via independent R&D projects and equity investment, as it transforms into a platform-based company.

How do we differ from the market? We are optimistic about the large merchant & e-commerce SaaS business.

Potential catalysts: The market of services for non-Taobao e-commerce platforms expands; e-commerce companies' demand for ERP products continues to increase.

Financials and valuation

We estimate that the firm's EPS will be -Rmb0.09 in 2022 and -Rmb0.04 in 2023. We initiate our coverage of Raycloud with an OUTPERFORM rating and a TP of Rmb11. Our SOTP-based TP offers 28% upside. The firm operates the traditional SaaS business and the traditional SaaS business and the large merchant & e-commerce SaaS business. We assign a valuation multiplier of 20x 2022e P/E to the traditional SaaS business, assuming net profit margin of this business at around 30%. We assign a valuation multiplier of 9x 2022e P/S to the large merchant & e-commerce business, as this business will likely become a main growth engine for the company.

Risks

Fewer paying users for traditional SaaS products; disappointing promotional campaigns for new products; overreliance on e-commerce platforms; higher-than-expected selling and R&D expenses.