Longtop and the remarkable capital efficiency of the Chinese cloud

A note on the comments: the comments on this post are consistently of the view that (a) the company did not build a cloud-based storage infrastructure, (b) they did not build a petabyte data storage solution for anyone, but (c) they assisted a customer build a large data set (probably not a petabyte) and (d) otherwise the press release is a marketing puff-piece but not material to the stock.  They think I have made too much of a marketing puff-piece.


I agree that it is entirely possible that the press release is a marketing puff piece of marginal importance to the stock.  It certainly has all the buzz-words.  Please do not read this post without reading the comments which are - in my view - sophisticated and probably contain some truth. At least they made me think.


Some people who I trust think this could be done within the $1.5 million of incremental capital spent this year.  I am not going to dispute that point - but whatever - it would use most of the $1.5 million of incremental capital... and that leaves the question how did they manage to to fund the rest of their growth.


The core issue remains - how is it possible that this company has grown equipment and fitting so slowly and revenue so fast? Unless there is a miracle they can't be doing it by owning cloud facilities. The company has grown revenue by almost 50 percent in the last nine months adding almost no fixed assets.


So I remain puzzled.


Now read the post - here without alteration:


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A while back I did a lot of work on cloud computing companies. This was not because I wanted to buy the cloud companies (by and large I do not) but because I wanted to understand what they did to the existing tech giants (such as Microsoft, Google, Apple, Hewlett Packard, Dell etc). You can find those posts here, here, here and here.

This stuff is important to us. Despite the (recent) content of this blog Bronte Capital's funds are primarily long equities. We short on the side. Recently shorts have been abnormally profitable. Long term returns will be driven by well-chosen value stocks.

We have big positions in selected tech giants - and we need to understand the threats to those businesses. So we went on a self-directed course in "cloud studies". [That course involved putting our own server and storage in the cloud...]

But you never know where your research will lead. "Cloud studies" took us to a remarkable press release from Longtop Financial - what appears as a reputable Chinese IPO (not a reverse takeover) with a reputable CFO. The remarkable press release described Longtop's efforts in being a cloud provider - and more particularly a cloud-storage provider.

Longtop Financial Technologies Limited (NYSE:LFT), a leading software developer and solutions provider targeting the financial services industry in China, today announced the official launch of its new data archiving solution. 

Like many organizations worldwide, financial institutions in China are experiencing explosive data growth. They are facing big challenges in continuing to store and manage the high-volume data for compliance purposes in a cost-effective way, as well as query and retrieve them efficiently for business needs. Longtop's data achieving solution has the capability to manage petabyte (PB) level structured data at both low cost and high access efficiency. The solution has the advanced data storage and management infrastructure built on cloud storage techniques, which has unlimited horizontal scalability in both storage volume and access efficiency with a high compression ratio. As a result, it can overcome the inherent deficiencies of traditional Relational Database Management System products in high-volume data management and help customers to build the new generation of data centers. 

"Much of the strength behind Longtop's solid organic growth track record comes from our proprietary product development. Over the years, we have consistently focused on Research and Development (R&D) and going forward we will continue to invest in human resources and technology to help further strengthen our R&D capabilities," commented Weizhou Lian, Longtop's Chief Executive Officer. "I am very pleased that one of the largest banks in China has been our first customer to deploy our data archiving solution."

What struck me as peculiar about this release is that being a cloud computing company is very capital intensive and I was wondering where they purchased their storage equipment from. After all storage equipment for the cloud is a hugely market-sensitive business (that was what the 3Par spat between Dell and HP was about see here and here).

More generally cloud computing is capital intensive. The cloud companies see themselves as utilities and have similar capital needs and economics. The main knock on the cloud computing businesses - as per this otherwise laudatory article about Rackspace - is that they are hugely capital intensive:

But analysts have questioned the capital-intensive nature of Rackspace's business model, especially because the company's capital-expenditure guidance will likely be higher than its revenue trajectory for 2011. 

"Our business will always be relatively capital intensive," he [Lanham Napier] said, largely because the company regularly has to upgrade its infrastructure. "The magic is in the margin of service layer we add on top of that infrastructure. We're making investments to continue to make the business more capital efficient, but we have more work to do on it."

And of all the cloud functions the one that is most capital intensive appears to be storage. You see when I am not using Bronte's server someone else can use the spare capacity. However when I am not accessing Bronte's storage nobody else can use it. Storage is not shared and thus likely to provide less capital advantage by going to "the cloud". And that shows in pricing - as Felix Salmon has noted cloud storage is too expensive for much personal use.

And yet Longtop have done cloud storage at the petabyte level (ie akin to Rackspace or Amazon) without very much capital expenditure. At the beginning of the 2010-11 financial year Longtop had fixed assets of $26.3 million. Nine months later - the nine months in which they launched their cloud storage offering - the fixed assets had risen to $27.9 million. Revenue grew in that nine months by over 40 percent (these numbers are in my previous post).

They managed to launch a cloud storage service at the petabyte level with almost no capital expenditure.

I was puzzled.

But the above mentioned remarkable press release told us that this amazing ability to do storage at the petabyte level with enough backup for a large financial institution came from their skills in human resource management. To quote again:

Much of the strength behind Longtop's solid organic growth track record comes from our proprietary product development. Over the years, we have consistently focused on Research and Development (R&D) and going forward we will continue to invest in human resources and technology to help further strengthen our R&D capabilities..."

These are remarkable skills. You see if Longtop can do this with only human resources (no substantial capital expenditure) then the $300 million odd of capex expected at Rackspace this year is wasted. There is probably half a billion of capex at Amazon EC2. That is wasted too.

Moreover because cloud storage can be done without buying capital equipment the huge bidding war between Hewlett Packard and Dell over 3Par (a company that sells capital equipment for cloud storage) was wasted and HP wasted billions of dollars.

It is all possible of course. Longtop are about to displace Amazon, Dell, HP, Rackspace and a score of other tech giants.

These Chinese companies really are that remarkable.

Just read the press release.





John