Talking Point

First impressions

Megvii is the first of China’s facial recognition firms to file for IPO

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Megvii technology is being used by police to hunt criminals

The social media sensation in China over the last week was a face-swapping app called Zao.

Similar services have been available in the past but Zao has been a breakaway success, winning fans from across the country.

Developed by Nasdaq-listed dating platform Momo, it allows its users to pick from hundreds of video clips, some of them classic movie scenes, and replace the star’s face with that of their own. All they need to do is provide a few selfies – taken from different angles and with different facial expressions – and Zao’s artificial intelligence (AI) will do the rest.

The software quickly became China’s most downloaded app – overloading the company servers. It popularity prompted a number of venture capital firms to woo Zao’s development team with funds.

Yet there was controversy too when Zao was forced to make a statement on Sunday pledging changes to its data privacy policies – which had given it free and ‘re-licenceable’ rights to all user-generated content.

Apart from the privacy row, critics have also warned against how it might be used for so-called ‘deepfakes’ (content that is distorted or superimposed with new images).

On Wednesday the Ministry of Industry and Information took note, asking the software developer to “rectify and improve” its business model.

After the initial enthusiasm there was anxiety Zao has been ‘harvesting’ faces to develop a facial recognition database that it can monetise. And that speculation was all the more topical given that Megvii, one of the best known unicorns in the facial recognition sector, had announced its plans for a listing in Hong Kong a few days before.

The IPO will offer investors their first opportunity to buy into a major, pure-play facial recognition firm. And in another tech landmark that company will be Chinese and not, as has been more customary, a product of Silicon Valley.

What does Megvii offer?

Founded in 2011, Megvii is best known for its Face++ system, which is capable of analysing more than 100 facial data points and confirming a person’s identity with a high degree of accuracy.

Face++ is an open platform that gives other developers access to its algorithms to create their own business applications. According to Megvii’s preliminary prospectus, the company is already the largest provider of cloud-based, facial recognition-powered identity authentifiers in China with a market share of 60%. And as of the end of June it was claiming 339 corporate clients from 112 Chinese cities.

Sales of “City IoT” services – its term for surveillance and security systems – made up more than 70% of its revenues last year. That also makes the Chinese government – at local and central level – one of Megvii’s key customers. Applications of its technology have been widespread, with the domestic press reporting that it has led to the arrest of more than 5,000 criminals (not a data point that gets a direct mention in its listing document).

Megvii’s software can also spot transgressions from drivers and initiate road management changes by reacting to traffic flows. It supports monitoring systems to public housing to allow entry only to recognised residents. And it is also being tested as a way of curbing subleasing in government-subsidised housing as well.

While law enforcement and security work has provided the bulk of Megvii’s revenue, its technology is also being deployed in retail and services contexts. Most notably, its major shareholder Alibaba used Megvii to power its “Smile to Pay” service at a concept store in Hangzhou (see WiC378). Didi Chuxing, China’s biggest car hailing firm, relies on the same technology to let passengers verify their driver’s identity. And Megvii software also powers device authentication for over 70% of the Android-based smartphones made in China (Huawei and Oppo are major clients).

Who is behind Megvii?

The company’s founder and CEO Yin Qi is just 35 years-old. Born to a middle-class family in Wuhu in Anhui province, Yin studied at Tsinghua under Andrew Yao, a winner of the Turing Award (the Nobel prize of the computer world). It was in Yao’s class that Yin met his two co-founders.

According to Xinhua, Yin is also a Communist Party member. In 2017, at one of the State Council’s consultation sessions with think tanks and entrepreneurs, he was described as the youngest attendee. That exclusive event saw him share his ideas with Chinese Premier Li Keqiang.

At the outset Megvii tinkered with smartphone photo applications and worked with dating sites. But Yin and his team soon attracted the attention of renowned private equity groups such as tech-focused Legend Holdings (parent of Lenovo) and they turned their focus more to surveillance and security.

Alibaba became an investor in 2014. Besides the financial support, China’s biggest e-commerce firm has helped to raise Megvii’s profile. For instance, Alibaba founder Jack Ma showed off Megvii’s ‘pay-with-your-face’ technology at an AI conference in Hanover in front of German leader Angela Merkel.

Together with its payment unit Ant Financial, Alibaba owns about 30% of Megvii. Yin and his two co-founders now own less than 10% of the shares. Yet they still exert control over the company through a dual-share structure that gives the partners more votes (Alibaba has something similar).

How much is Megvii worth?

According to Reuters, a fundraising round earlier this year valued it at about $4 billion, but its backers will want a higher price once it lists on Hong Kong’s stock exchange.

Reportedly company executives are hoping to raise up to $1 billion in its initial public offering – which will break new ground as the first AI stock to go public in the city.

Megvii has its fair share of competitors. Inside China the main rivals are SenseTime (also backed by Alibaba, see WiC405), Yitu and CloudWalk. Together with Megvii the group is known collectively as “the four little AI dragons”. The other members of the quartet also want to go public, although local media reports say they have been sizing up the newly-established STAR bourse in Shanghai instead (see WiC461).

AI concept stocks aren’t entirely new to investors in China. iFlytek, an AI firm that specialises in voice recognition technology, went public in Shenzhen as long ago as 2008. It was worth Rmb76 billion ($10 billion) this week – a valuation of 120 times its 2018 earnings. Some analysts are now benchmarking Megvii against iFlytek, although the IPO candidate is yet to make a profit. In fact it lost Rmb3.4 billion last year (on revenues of Rmb1.4 billion, more than four times its 2017 sales).

iFlytek is trading at about 6.4 times its 2018 sales. Megvii would need to price itself on a higher premium – at least 7.5 times sales – to get the IPO away at a market value that comes close to its $4 billion valuation target. Is that realistic, Caixin Weekly asked, noting the uncertainty over whether Megvii would reach profitability in the next two or three years.

How big is the facial recognition market?

According to Megvii’s filing, there are already about 210 million surveillance cameras installed across China, although it says most of these are outdated and require replacement.

It also estimates there are at least 1.2 million locations where new facial recognition systems are required for the premise’s entrances. In Beijing alone 13 public rental housing communities installed entranceway facial recognition in July – and 46 more will do so by October.

Megvii reckons the overall market for its services was worth Rmb300 billion last year but that it is still growing rapidly.

It also goes without saying that the Ministry of Public Security is an important focus for all of the facial recognition unicorns. For instance, Chinese police are relying on them to pluck suspects from crowds (we have reported on the fugitives arrested at Jacky Cheung concerts; see WiC410) and some police forces have been relying on Google Glass-style devices to allow their cops to scan faces while they patrol the streets. Local authorities are looking to use facial recognition more – for everything from paying subway fares to fining jaywalkers.

The ‘AI dragons’ are also eyeing overseas markets, where Chinese firms are already sitting on an estimated 40% share of the ‘security solutions’ market.

Countries such as Brazil and India have been bigger buyers in recent years and Megvii says it is well-positioned to capture more opportunities abroad.

In fact, it plans to allocate some of the proceeds from its IPO to bankroll its overseas expansion. “With the help of our investors and customers, we aim to accelerate our development as a trusted global leader in AI and internet of things, empowering humans and enabling industrial progress,” Yin Qi wrote in a letter to investors included with its listing document.

Is Megvii a reliable bet?

Megvii has a research lab in Seattle but the US market seems unlikely to be an enthusiastic customer for its services – or for any of the other Chinese AI firms.

Tensions unleashed by the Sino-US trade row have already put telecom major Huawei on the sanctions list and Megvii warned in its listing document that this is a risk factor for its investors as well.

In May American media reported that the US government was thinking about expanding its blacklist to other Chinese tech firms, including Megvii, drone maker DJI and the surveillance camera maker Hikvision (see WiC375). Back in China this threat was regarded as a “badge of honour”, given the widespread perception that it is only the most tech-savvy Chinese firms that are getting scrutiny from Washington. Nonetheless, Megvii is bound to face more questions about its links to the Chinese state as it courts more investors and customers from overseas.

Megvii says 4.9% of its revenues came from outside China in the first half of this year, compared with 2.7% for all of 2018. The plan is to launch joint ventures in places like Thailand and the Middle East. But critics of the company will ask questions about its links to the Chinese state and query whether Megvii can meet appropriate privacy standards, especially in European and North American markets.

Indeed, news about it being a potential addition to Washington’s watchlist emerged only a month after reports in the international media that it was involved in one of the world’s most sophisticated surveillance system in the restive Chinese region of Xinjiang.

Megvii then found itself enmeshed in another unwelcome debate this week. Promotional video for its roadshow had shown its equipment at work monitoring student behaviour in a classroom (catching, for instance, that a student might be daydreaming, based on facial expressions). A screenshot of the clip went viral online, with netizens soon questioning whether Megvii was infringing student rights with such intrusive applications. It responded that the video was only a product demonstration and that its main focus in the education sector was improving campus safety (a growing concern for Chinese parents following a series of knife attacks in recent years). But it was another reminder that facial recognition firms are working in sensitive areas. Megvii is aware of the risks to its reputation, making plain in its prospectus that “rumours or negative publicity” about how its software is applied are a genuine threat to its image and growth prospects.

Big brother is watching…

The Chinese government has already provided significant financial and policy support to the nation’s burgeoning AI sector. There are hundreds of new entrants in the industry: the World Artificial Intelligence Conference (WAIC) kicked off in Shanghai last week with more than 300 firms, a 50% increase in exhibitors on the previous year.

There is, of course, no certainty that the four AI dragons will emerge as genuinely dominant tech titans. Also in the news at the Shanghai conference last week was a new “national open innovation platform for next generation AI” that aims to encourage domestic firms to share their source code. The question is whether collective efforts like these might reduce some of the early-mover advantages enjoyed by the likes of iFlytek and Megvii. And the AI quartet might also need to deal with a major new competitor like Hikvision, which could scale up its own R&D in facial recognition or acquire one of the dragons and merge it with its vast surveillance camera business.

The potential synergies from such a deal must be tempting, given the government’s Orwellian vision of covering the country with its ‘Skynet’ surveillance system. n


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