2Q revenue beat expectations, but net profit lagged; AI agent potential still depends on user adoption, payment rates, and cost improvements

Overview

The report reviews Kingsoft Office's 2Q26 results and key takeaways from management's conference call. Revenue beat expectations, driven by growth in ToC subscriptions and WPS 365, but changes in product mix, R&D investment in new AI products, and higher expenses weighed on profitability. Goldman Sachs therefore lowered its 2026 earnings forecast while maintaining its Sell rating and RMB201 target price.

Core views

2Q26 revenue exceeded expectations, but profit significantly lagged. Revenue rose 25% YoY to RMB1.7bn, 7% above both Goldman Sachs and Bloomberg forecasts. The main drivers were 17% YoY growth in the ToC subscription business and 60% YoY growth in WPS 365. However, changes in product mix reduced gross margin to 83.3%, below 84.1% in 2Q25 and 86.6% in 1Q26. Operating profit rose 34% YoY to RMB352mn but was still 21% below Goldman Sachs' forecast due to higher-than-expected R&D expenses. Net profit was RMB322mn, 38% below Goldman Sachs' forecast. This indicates that revenue growth has not yet fully translated into the expected incremental earnings. The company continues to view AI as a key driver of ToC and ToB subscription growth. Following the launch of the Lingxi AI agent, management plans to integrate more WPS functions into Lingxi to attract new users. During the World Artificial Intelligence Conference, the company launched Lingxi Professional Edition for ToC users, enabling more complex office tasks through documents, code, and browsers. For ToB customers, it launched WPS AI Comate and integrated enterprise knowledge into the product. Management expects these functions to help increase payment rates, but the report also emphasizes that improvements in payment rates and user adoption will take time, and the impact of AI products on revenue and spending will not be fully realized immediately. AI agents also create greater cost pressure. Management noted that AI agents consume more tokens than other AI products, and the company continues to optimize its models to improve its cost structure. Therefore, while new AI products may expand user adoption and spending, they also increase R&D and inference costs. Near-term profitability will depend on whether adoption, monetization, and cost optimization can advance in tandem. After incorporating the 2Q26 results into its forecasts, Goldman Sachs lowered its 2026 earnings forecast by 5%. The revision reflects a higher revenue forecast but greater-than-previously-expected operating expenses related to new-product R&D. The 2027 and 2028 earnings forecasts remain broadly unchanged, indicating that Goldman Sachs primarily views the current pressure as a result of increased near-term investment and has not materially changed its earnings framework for subsequent years. The target price continues to be calculated using a two-stage DCF to reflect long-term cash flow generation capacity. Goldman Sachs assumes annual free cash flow growth of 12% during the second stage from 2032 to 2036, unchanged from its previous assumption. The terminal growth rate is 2%, consistent with its China technology sector coverage framework. The discount rate uses a WACC of 12.1% and a cost of equity of 12.1%, based on a beta of 1.4, a risk-free rate of 3.0%, and an equity risk premium of 6.5%. This results in an unchanged target price of RMB201. The target price implies a 2027E P/E multiple of 31x, below the company's historical average less one standard deviation of 44x. Goldman Sachs therefore believes the company's current valuation remains elevated and maintains its Sell view.

Analysis framework

Goldman Sachs first compares 2Q26 revenue, margins, operating profit, and net profit against the prior-year base and its own and Bloomberg's forecasts, then explains the differences through ToC subscriptions, WPS 365, product mix, and R&D expenses. It subsequently assesses the impact of Lingxi and WPS AI Comate on user adoption, payment rates, and the cost structure based on management's conference call and adjusts its earnings forecasts accordingly. Finally, it calculates the target price using a two-stage DCF and cross-checks it against the 2027E P/E multiple and the historical valuation range.

Methodology notes

• Valuation MethodologyDCF Valuation

  Two-stage DCF valuation

  The report discounts future free cash flows to present value, assuming annual free cash flow growth of 12% during the second stage from 2032 to 2036, a terminal growth rate of 2%, and a WACC of 12.1%, resulting in a 12-month target price of RMB201.

• Valuation MethodologyP/E and PEG Valuation

  Comparison of the target price's implied P/E multiple with the historical valuation range

  The report compares the target price's implied 2027E P/E multiple of 31x with the company's historical average less one standard deviation of 44x as supporting evidence for its view that the current valuation is elevated.

• Corporate Fundamentals and Financial FrameworkOperating/Financial Leverage Analysis

  Transmission of revenue growth, gross margin, and R&D expenses to profit

  The report compares changes in revenue, gross margin, operating profit, and net profit, explaining that the revenue beat did not fully translate into earnings because changes in product mix reduced gross margin and R&D expenses for new AI products exceeded expectations.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Kingsoft Office (688111.SS)

  The report's sole covered company; AI agent products are viewed as potential drivers of ToC and ToB subscription growth, but near-term R&D investment, inference costs, and the adoption ramp-up constrain earnings realization.

  Strengths

  2Q26 revenue rose 25% YoY and beat expectations, ToC subscriptions grew 17%, and WPS 365 grew 60%. Lingxi and WPS AI Comate expanded the company's personal and enterprise AI office product offerings.

  Weaknesses

  Gross margin declined to 83.3%, while operating profit and net profit were 21% and 38% below Goldman Sachs' forecasts, respectively. AI agents consume more tokens, and improvements in user adoption and payment rates will take time.

  Comparison

  2Q26 revenue was 7% above both Goldman Sachs and Bloomberg forecasts. The target price implies a 2027E P/E multiple of 31x, compared with the company's historical average less one standard deviation of 44x.

  Risks

  Upside risks to the Sell view include faster-than-expected membership system conversion, ToB customer adoption, or AI monetization.

Key data

• 2Q26 RevenueRMB1.7bnUp 25% YoY and 7% above both Goldman Sachs and Bloomberg expectations
• ToC Subscription Business GrowthUp 17% YoYOne of the main drivers of 2Q26 revenue growth
• WPS 365 GrowthUp 60% YoYMaintained strong growth in 2Q26
• 2Q26 Gross Margin83.3%Versus 84.1% in 2Q25 and 86.6% in 1Q26; the report attributes the decline to changes in product mix
• 2Q26 Operating ProfitRMB352mnUp 34% YoY but 21% below Goldman Sachs' forecast due to higher-than-expected R&D expenses
• 2Q26 Net ProfitRMB322mn38% below Goldman Sachs' forecast
• 2026 Earnings Forecast RevisionCut by 5%Revenue forecast raised, but operating expenses related to new-product R&D were higher than expected
• 2027 and 2028 Earnings ForecastsBroadly unchangedRevision after incorporating the 2Q26 results
• 12-Month Target PriceRMB201Based on a two-stage DCF, unchanged
• 2032-2036 Free Cash Flow Growth12% annuallyDCF second-stage assumption, unchanged
• Terminal Growth Rate2%Consistent with Goldman Sachs' China technology sector coverage framework
• WACC12.1%DCF discount rate
• Cost of Equity12.1%Based on a beta of 1.4, a risk-free rate of 3.0%, and an equity risk premium of 6.5%
• Target Price-Implied 2027E P/E31xBelow the company's historical average less one standard deviation of 44x

Impact & implications

The report believes that the subscription business and WPS 365 demonstrate that the company still has strong revenue growth momentum, while Lingxi and WPS AI Comate may also expand user adoption and spending. However, AI user adoption and payment rates will take time to ramp up, and higher R&D and token costs are pressuring near-term profitability. Based on its DCF and valuation comparison, Goldman Sachs maintains its Sell rating and RMB201 target price.

Risks

• Faster-than-expected conversion to the new membership system could represent an upside risk to the Sell view.
• Faster-than-expected ToB customer adoption could drive stronger enterprise subscription growth.
• Faster-than-expected AI monetization could lead to revenue and earnings improvements exceeding the report's forecasts.

What to watch

• Monitor the pace at which new-user adoption and payment rates ramp up after more WPS functions are integrated into Lingxi.
• Monitor the adoption progress of WPS AI Comate among ToB customers.
• Monitor AI agent token consumption and the extent to which model optimization improves the cost structure.
• Monitor the ongoing impact of new-product R&D investment on operating expenses and 2026 earnings.