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Making more sense

SenseTime stock spikes higher after Hong Kong IPO, despite US sanctions

Sensetime-NYSE-w

The algo IPO: China’s AI giant SenseTime made its stock market debut in Hong Kong in late December

The 1956 novel Minority Report, which was turned into a blockbuster film of the same name by Steven Spielberg in 2002, underlined the Cold War anxieties of its author Philip Dick. It also questioned whether technological breakthroughs would help tyranny prevail over liberty.

Many of the fictional technologies portrayed by Dick half a century ago are now today’s reality as touch screens, retina scans and personalised advertising have all become fixtures of everyday life. Predictive policing and self-driving cars are not yet so widespread. For them to become more commonplace, further breakthroughs in technologies like algorithmic surveillance are required.

An eight year-old firm from China called SenseTime is a major part of the revolution in artificial intelligence, with know-how that could help governments better manage their cities and carmakers roll out vast fleets of driverless vehicles. Fuelled by an atmosphere of deeply entrenched trade and tech tension between China and the US, the company has also found itself as a subject of suspicion in Washington political circles, however. Indeed, SenseTime is now on the receiving end of some of the same sanctions efforts that have hampered 5G leader Huawei’s commercial prospects for much of the last 18 months.

Yet the adverse attention seems to have done little to take the shine off the AI developer’s recent IPO in Hong Kong.

Step forward SenseTime…

Paradoxically many Chinese now view American sanctions as a badge of honour for China’s tech champions. They see it as an alternative gauge for measuring the relative strengths of their tech firms: only companies in possession of advanced technologies are deemed a threat by the Americans and thus ‘make the grade’ for the sanctions blacklist.

As a result Huawei, which has braved a full-frontal assault from the US government since 2018, has enjoyed enhanced status as a national champion back at home.

Perhaps this also explains some of the enthusiasm from investors for the shares of SenseTime, which went public on Hong Kong’s main bourse at the end of last month, with the narrative that it is a key cog in some of the most anticipated trends in China’s tech world.

SenseTime was scheduled to debut on December 17 but its listing plan was nearly derailed by a late intervention from the US Treasury Department, which announced its intent to add SenseTime to a sanctioned group of “Chinese military-industrial complex companies” just as the AI firm was conducting its roadshow last month.

With the allegation that SenseTime’s facial recognition (FR) software was being used to identify ethnicity in Xinjiang, Washington’s decision effectively barred most American investors from investing in the company. The Chinese firm was forced to relaunch its IPO preparations, excluding a number of ‘cornerstone investors’ from the US and replacing them with Chinese entities, such as the state-backed Mixed-Ownership Reform Fund. A number of American fund managers were said to have pulled their orders from the IPO’s original institutional tranche as well.

SenseTime has denied that its technology is being deployed in measures to monitor the ethnic Uighurs in Xinjiang. “The accusations are unfounded and reflect a fundamental misperception of our company. We regret to have been caught in the middle of geopolitical tensions,” it said in a statement. SenseTime further clarified in a filing that Washington’s restrictions target just one of its units and claimed that they “do not at present” apply to the parent firm.

Chinese AI firms have been watched closely in Washington for a while. Megvii, one of the so-called ‘four little AI dragons’ (together with SenseTime, Yitu and CloudWalk), had filed for a Hong Kong listing as long ago as 2019 (see WiC465). Its IPO was shelved after the US government put Megvii and SenseTime on an entity list and barred them from buying US technology. The decision to postpone the Megvii share sale was then made, the Chinese press reported at the time, to protect potential shareholders (including American ones) from uncertainty about the impact of the sanctions.

SenseTime finds itself in a similar situation now, with existing shareholders including US private equity firm Silver Lake and chipmaker Qualcomm. It is not immediately clear if they’ll need to divest their stakes. But the Chinese AI giant decided not to shelve its market debut, pressing ahead with its Hong Kong IPO instead.

How have SenseTime’s shares performed?

The company came to market amid bearish sentiment in Hong Kong. The bourse has retreated nearly 20% in the past six months, largely thanks to the Chinese government’s crackdown on its domestic internet sector.

SenseTime still managed to maintain an unchanged fundraising of about HK$5.8 billion ($750 million), although underwriters had to price the IPO at the lower end of the price range. The first ‘AI concept stock’ to list in Hong Kong then climbed 7% from its HK$3.85 offering price on its trading debut on December 30. But it then enjoyed a rally that saw its shares more than double in price in the days that followed. As of Thursday, the lossmaking firm was trading at about HK$7 a share on a market value of HK$273 billion.

The strong performance is partly a result of a less-than-aggressive pricing strategy at the outset, because of the weak market conditions. A small public float has helped as well. About 5% of SenseTime’s share capital is available for trading, with a large amount of the IPO taken up by state-backed cornerstone investors, which are subject to a six-month lockup period.

Nevertheless local market commentators believe much of the share price support has come from Chinese investors who want their country to stay ahead in the AI race with the Americans. Financial columnist Chan Yan Chong described it as an “in-your-face” rally and told news portal HK01 it was an implicit rebuke for Washington’s sanctions. However, he also warned that SenseTime may face more punitive measures from the US government in future.

There are many, of course, that see fundamental value in investing in a leading artificial intelligence firm in the Chinese market, especially at a time when other tech champions seem to have lost favour with the local authorities. “AI is an industry with strong support from the central government. Tencent and Alibaba are now considered ‘old’ economy, but SenseTime belongs very much in the ‘new’ economy. It could be the star stock of the next decade, becoming the next Tencent,” local brokerage Canfield Securities noted exuberantly, referring to Tencent’s nearly 1,000-time share price spike since going public in Hong Kong in 2004.

Who are the faces behind SenseTime?

Megvii and CloudWalk have both filed to go public on Shanghai’s STAR Market. SenseTime preferred Hong Kong, in part – as the city’s government put it – because it is a “home-grown Hong Kong company”. It’s an ambitious claim, although the science and technology park where SenseTime staff did some of their early work has been claiming it as Hong Kong’s first unicorn for a while (having now floated its shares SenseTime has shed its unicorn status).

The same assertion helps Hong Kong’s policymakers counter the suggestion that the real estate-obsessed city is hopeless at tech start-ups (the naysayers charge that its economy has been dominated by property heavyweights that spend next to nothing on R&D).

SenseTime was incorporated in Hong Kong in 2014 and established its global headquarters in the territory in the same year. The creation of the AI start-up began with Tang Xiaoou. Born in 1968, the Liaoning native received a PhD from MIT, where he joined the deep-sea robotics lab and witnessed the power of AI in uncovering the site of the Titanic shipwreck.

Later Tang took up a teaching post at the Chinese University of Hong Kong (CUHK) and established an AI multimedia lab there in 2001. But he soon identified a problem: CUHK wasn’t attracting the best Chinese students, many of whom aspired to study in the US. His solution was to help to arrange for more of his graduates to further their studies at a later point at elite US universities. And once Tang became better known for offering a springboard to the Ivy League, his lab lured more of the best science and engineering candidates from Chinese colleges, including Tsinghua. He thus cultivated a growing pool of premier AI talent.

Among them was Xu Li, who received a doctorate in computer vision and imaging at CUHK in 2010. Now 39 and the CEO of SenseTime, Xu co-founded the AI start-up with Tang. The duo have operated according to a very simple strategy: to leverage their web of connections and bring as many of the best AI scientists and researchers to SenseTime as possible.

Tang believes that if this talent pool is kept wide and deep, SenseTime’s technology will lead that of its rivals. According to its IPO prospectus, there are more than 250 professors or PhD holders working for the company, along with more than 3,000 scientists and engineers. This strategy has also proved appealing for angel investors like IDG, which decided to bet on SenseTime way back in 2014, Fortune China reported, after noticing that 14 of the 29 leading academic papers on deep learning between 2011 to 2013 came from SenseTime team members.

How does SenseTime make money?

SenseTime began offering its services commercially in 2015. Its first big break came from a deal with China Mobile, the world’s biggest wireless telecoms carrier. At the time, the state-backed telco was on the verge of losing a chunk of its revenue to a government crackdown on unregistered SIM cards. Most of the owners of these 300 million prepaid cards were expected to ditch them if they were required to make the effort to visit a China Mobile branch and have their faces and ID cards scanned personally. But SenseTime’s FR technology, which boasted 99.15% in verification accuracy in 2014, came to the rescue. Cardholders just needed to snap photos of their faces and ID cards and send them to China Mobile. SenseTime’s tech did the rest.

This was still no easy task for the company. Besides facial recognition, SenseTime’s AI also needed to identify the Chinese characters printed on customer ID cards. But there was a pay-off: AI algorithms get smarter as they are fed more information. Data from China Mobile’s 300 million prepaid card customers offered a golden opportunity to train SenseTime’s software better, Fortune China reported.

China has since become SenseTime’s biggest market, accounting for more than 85% of its revenue. Many of its largest contracts derive from local governments and state enterprises, with its top five clients accounting for nearly 60% of its income for the first half of 2021.

Revenue grew from Rmb1.8 billion ($282 million) in 2018 to Rmb3.4 billion in 2020, although operational losses reached Rmb3 billion during the period, because of increasing spending on R&D, which topped 107% of its sales last year. That ratio is likely to stay high in the short term, given that SenseTime has earmarked 60% of its IPO proceeds for R&D.

Investors will hope that sales growth will outpace its increases in R&D spending. According to Securities Daily, the company is hopeful of bagging more government contracts as officials rely more on AI to govern their municipalities. SenseTime’s surveillance algorithms are said to be able to detect whether drivers are wearing seatbelts, for instance, and identify instances in which rubbish is being dumped illegally on backstreets. The company also reckons the new era of driverless vehicles will bring tremendous growth prospects. At present this business segment accounts for less than 5% of its revenues. But if SenseTime’s tech is used to support the kind of centralised transport systems portrayed in Minority Report, its prospects should prosper. Indeed, investors are clearly intrigued by the company’s potentially transformative impact on many of the ways that urbanites live and travel, regardless of the more immediate uncertainties surrounding Washington’s blacklisting of the AI firm…


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