China AI capital expenditure and product upgrades support Iluvatar's rapid growth; Goldman Sachs reiterates Buy

Overview

The report focuses on China AI demand, Iluvatar's chip shipments and product upgrades, earnings forecast revisions, and valuation. Goldman Sachs believes that China's AI capital expenditure cycle and expansion of the domestic ecosystem will support the company's long-term growth. It therefore raises its forecasts for future shipments, revenue, and profit while maintaining its Buy rating and HK$1,000 target price.

Core views

The report first uses the capital expenditure of China's major cloud service providers to validate the strength of AI demand. In the second quarter of 2026, Tencent's capital expenditure grew 176% year over year to RMB52.8 billion, Baidu's increased 202% year over year to RMB11.4 billion, and Alibaba's rose 75% year over year to RMB67.7 billion. Goldman Sachs believes these figures show that AI investment in China remains ongoing and will support demand for domestic AI chips and Iluvatar's subsequent growth. At the company level, the growth thesis consists of four factors: first, China's AI capital expenditure is entering an upward cycle; second, the domestic ecosystem encompassing AI chips, servers, networking, foundation models, and AI applications continues to expand; third, the product mix is shifting toward AI chips and next-generation products with stronger computing performance and higher average selling prices; and fourth, the customer base is expanding to domestic cloud service providers. Based on these assessments, Goldman Sachs raises its AI chip shipment forecasts for the coming years and expects Iluvatar's net profit CAGR to reach 104% from 2027 to 2030. The earnings forecast revisions also reflect the trade-off between growth and investment. Incorporating the company's net profit guidance for the first half of 2026, Goldman Sachs raises its revenue forecasts for 2027 to 2030 by 49%, 45%, 37%, and 27%, respectively, mainly due to higher AI chip shipments and an improved blended average selling price driven by a greater share of next-generation products. It raises its net profit forecasts for the same period by 20%, 19%, 17%, and 11%, respectively. These increases are smaller than the revenue upgrades, reflecting pressure from margins and R&D investment. The report lowers its gross margin forecasts for 2026 to 2030 because the customer base is expanding toward cloud service providers with stronger bargaining power, while large-volume purchases typically correspond to more favorable procurement prices. It also raises its R&D investment forecasts for 2026 to 2030 to support product specification upgrades. The 2026 net profit forecast was revised to a profit, although the report notes that it includes non-operating gains such as fair value gains on financial assets. Regarding valuation, Goldman Sachs maintains its 12-month target price of HK$1,000 and uses a discounted 2030 EV/EBITDA methodology to reflect the company's long-term growth. The report applies a target EV/EBITDA of 23.4x to forecast 2030 EBITDA and discounts it back to 2027 using a 12.7% cost of equity. The cost-of-equity assumptions include a Beta of 1.5, a risk-free rate of 3.0%, and a market risk premium of 6.5%. The target multiple is derived from the relationship between comparable companies' forward EV/EBITDA and year-over-year EBITDA growth, combined with Iluvatar's projected average forward EBITDA growth of 31% year over year in 2031 to 2032. The target multiple was lowered from the previous 26.1x to 23.4x because market concerns about AI monetization led to a sector valuation de-rating. Nevertheless, the report maintains its target price and Buy rating.

Analysis framework

Goldman Sachs first assesses the AI demand cycle using the capital expenditure growth of major Chinese cloud service providers, then maps the expansion of the domestic AI ecosystem to Iluvatar's chip shipments, product mix, and customer coverage. It subsequently adjusts revenue forecasts based on shipments and average selling prices and revises profit forecasts by incorporating cloud service providers' bargaining power, changes in gross margin, R&D investment, and non-operating gains. For valuation, the report determines the target multiple based on the relationship between comparable companies' EV/EBITDA and growth rates, then uses the cost of equity to discount the 2030 valuation back to 2027.

Methodology notes

• Valuation MethodologyEV/EBITDA valuation

  Discounted 2030 EV/EBITDA valuation

  The report applies a target EV/EBITDA of 23.4x to Iluvatar's forecast 2030 EBITDA and then discounts it back to 2027 to determine the 12-month target price of HK$1,000. The target multiple references the relationship between comparable companies' valuations and EBITDA growth rates while also considering Iluvatar's long-term growth.

• Quantitative/Factor/Portfolio TheoryCAPM Capital Asset Pricing Model

  Cost-of-equity estimation

  The report derives a cost of equity of 12.7% using a Beta of 1.5, a risk-free rate of 3.0%, and a market risk premium of 6.5%, which is used to discount the 2030 valuation back to 2027.

• Industry/Sector Analysis FrameworkPrice-Volume Decomposition

  Decomposition of chip shipments and blended average selling price

  The revenue forecast upgrades are decomposed into higher AI chip shipments and growth in the blended average selling price resulting from an increased share of next-generation, high-performance products, thereby distinguishing the contributions of sales volume and product mix to revenue.

• Industry/Sector Analysis FrameworkUpstream-Midstream-Downstream Industry Chain Transmission

  Transmission from cloud service provider capital expenditure to domestic AI chip demand

  The report uses capital expenditure growth at Tencent, Baidu, and Alibaba as evidence of downstream AI investment and concludes that demand will transmit to domestic AI chips, servers, networking, foundation models, and application ecosystems, thereby supporting Iluvatar's shipment growth.

Asset mapping & comparison

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

• Iluvatar (9903.HK)

  Growth in China's AI capital expenditure, expansion of the domestic AI ecosystem, increased chip shipments, and product mix upgrades are expected to drive the company's revenue and profit growth.

  Strengths

  The company benefits from demand for AI chips in China and the domestic substitution trend. Its product portfolio is upgrading toward next-generation AI chips with greater computing performance and higher average selling prices, while its customer base is also expanding to domestic cloud service providers.

  Weaknesses

  Large cloud service providers have stronger bargaining power, which may depress gross margins; continued product specification upgrades require increased R&D investment, and the forecast profit for 2026 includes non-operating fair value gains.

  Comparison

  The target valuation multiple is determined based on the relationship between comparable companies' forward EV/EBITDA and EBITDA growth rates, combined with Iluvatar's average year-over-year EBITDA growth of 31% in 2031 to 2032.

  Risks

  Demand for AI chips in China may be weaker than expected, market competition may intensify beyond expectations, or product migration may proceed more slowly than expected.

Key data

• Tencent's capital expenditure in the second quarter of 2026RMB52.8 billionUp 176% year over year
• Baidu's capital expenditure in the second quarter of 2026RMB11.4 billionUp 202% year over year
• Alibaba's capital expenditure in the second quarter of 2026RMB67.7 billionUp 75% year over year
• Forecast net profit CAGR from 2027 to 2030104%Driven by the AI capital expenditure cycle, expansion of the domestic ecosystem, product upgrades, and customer expansion
• Revenue forecast revisions for 2027 to 2030+49%/+45%/+37%/+27%Corresponding sequentially to 2027E, 2028E, 2029E, and 2030E
• Net profit forecast revisions for 2027 to 2030+20%/+19%/+17%/+11%Corresponding sequentially to 2027E, 2028E, 2029E, and 2030E
• 12-month target priceHK$1,000Maintained unchanged
• Target EV/EBITDA23.4xPreviously 26.1x; lowered due to a sector valuation de-rating triggered by concerns about AI monetization
• Valuation discount rate12.7%Cost of equity; Beta of 1.5, risk-free rate of 3.0%, and market risk premium of 6.5%
• Average year-over-year EBITDA growth in 2031 to 203231%Used to support the determination of the target EV/EBITDA multiple

Impact & implications

The report believes that China's AI spending and domestic substitution trends will drive increases in Iluvatar's shipment volume, product performance, and average selling price, thereby significantly raising the future revenue and net profit base. However, expanding the customer base to large cloud service providers may depress gross margins, while continued product upgrades will require greater R&D investment. In addition, part of the return to profitability in 2026 depends on fair value gains on financial assets rather than entirely on operating improvements. The lower valuation multiple reflects market concerns about AI monetization, but Goldman Sachs maintains its long-term growth outlook, Buy rating, and HK$1,000 target price.

Risks

• Demand for AI chips in the Chinese market may be lower than expected.
• Market competition may be more intense than expected.
• Product migration and upgrade progress may be slower than expected.

What to watch

• Monitor whether AI capital expenditure by Chinese cloud service providers can sustain its current growth trend.
• Monitor the growth of Iluvatar's future AI chip shipments and the pace of increase in the share of next-generation products.
• Monitor whether product mix upgrades can continue to raise the blended average selling price.
• Monitor the impact of cloud service provider customer expansion on procurement prices and gross margins.
• Monitor whether increased R&D investment can support product specification upgrades and migration progress.
• Monitor the composition of operating profit and fair value gains on financial assets within 2026 earnings.