(Bloomberg) -- The co-founder of China’s SenseTime Group Ltd. was visiting New York to encourage more collaboration with the U.S. on artificial intelligence when he heard the news: The Trump administration had blacklisted his company. So much for more cooperation.
Xu Bing, the 29-year-old co-founder, knew SenseTime was at risk given rising tensions between China and the U.S., but the timing took him by surprise. He was spending a few days showing off his latest products and meeting other AI researchers earlier this month when the Commerce Dept. put his company and seven others on its “Entity List,” prohibiting American companies from providing crucial supplies like semiconductors. His phone flooded with calls and emails from worried employees and investors.
SenseTime is emblematic of the clash between the world’s two biggest economies. China is seeking to evolve economically by moving beyond manufacturing into the technology vanguard, with the explicit goal of dominating key fields like AI. Donald Trump’s administration is increasingly adamant about containing China’s rise, arguing that companies like Huawei Technologies Co. steal intellectual property and threaten national security, while startups like SenseTime and Megvii Technology Ltd. are complicit in human rights violations in the country’s Xinjiang region.
The company’s founders are a bit stunned at getting caught in the crossfire. They are mostly academics who decided to commercialize their technology five years ago, drawing attention from both U.S. and China governments because of the applications for surveillance. Now, they plan a shift away from hardware, which requires American chips, to focus on software for facial recognition and other applications. The founders think they can survive the existential threat.
“Long-term, the fundamentals of business are still most important,” says Xu, “so that’s what we will focus on.”
SenseTime, whose $7.5 billion valuation is the highest for an AI startup in the world, is trying to reassure investors, employees and customers. The company said in a statement that it is “deeply disappointed” at the blacklisting decision and will seek relief. It emphasized it complies with all laws in local jurisdictions.
“These are real risks for tech companies in China,” says Crawford Del Prete, president of the market research firm IDC.
SenseTime has been preparing for the worst. The company raised about $2.5 billion last year from investors including Japan’s SoftBank Group Corp. and Singapore’s Temasek Holdings Pte., according to a person familiar with the matter. That forestalls the need for an initial public offering any time soon.
Megvii, another AI startup that was blacklisted this month, is pressing ahead with its IPO plans, effectively testing whether investors will take on the risks of a blacklisting. (Megvii also says it’s done nothing wrong and plans to fight the U.S. ban.)
For SenseTime, the biggest challenge of the Trump move is that it will lose access to U.S. semiconductors, particularly from Nvidia Corp. The chips are incorporated into AI cameras and other hardware SenseTime sells to corporations and government agencies. Without them, SenseTime will be able to market software that customers or resellers can then install on their own cameras or servers -- but not the hardware itself. That will likely cut into growth, given that hardware accounts for about half its revenue. Software sales tend to be higher margin.
Sales are likely to triple this year to about $900 million, according to people familiar with the matter. Even though growth is expected to flag, revenue may still double annually for the next three years, the people said.
“We’re very much prepared for the long game,” says Xu Li, chief executive officer of SenseTime and another co-founder.
All this is a far cry from the company’s debut in 2014. Xu Li was a PhD student in computer science at the Chinese University of Hong Kong when he hit it off with a few other AI academics and they founded SenseTime.
It didn’t go smoothly. Xu spent most of his time recruiting scholars rather than calling on customers. Skeptical salespeople fled. Finally, a venture investor warned Xu he needed a business plan.“You recruit PhDs and publish papers. You’re not making a company, you’re making a university,” Xu recalls the backer telling him.
After nine months without any sales, Xu stumbled on an opportunity. Peer-to-peer lending was taking off in China, but fraud was so common that companies were desperate for help. SenseTime devised a system to conduct face scans with motion -- turn your head, wink, stick out your tongue -- to prove users were real people. The first client paid 20 million yuan ($2.8 million). Soon, companies were lining up for its services.
Next, smartphone maker Xiaomi Corp. asked for support in creating customized photo albums for users. Then Bytedance Inc., the parent of viral short-video app TikTok, tapped SenseTime to build filters that beautify streamers by slimming faces and toning complexions in real time as they sing and dance.
Business really took off with security-camera technology. China’s public security bureau owns about 30 million surveillance cameras, but only about 1% are so-called smart cameras that can analyze what they’re recording. It costs $500 to $3,000 to upgrade a device, depending on how many functions one wants — to identify faces, traffic, a fire or an explosion. Providing software to upgrade government cameras accounts for about 35% of SenseTime’s revenue, according to people familiar.
The rest of the company’s revenue comes from commercial clients like property developers, shopping malls and mobile phone providers, the people said. There were about 176 million video surveillance cameras monitoring China’s streets, buildings and public spaces in 2016, compared with 50 million in the U.S., according to IHS Markit.
The company emphasizes it doesn’t do business directly with government agencies. But the public security bureau can buy its software and products via third party providers. Its software is compatible with cameras made by Sony Corp (T:6758)., Samsung Electronics (KS:005930) Co. and Panasonic Corp.
Competition is tough. Some clients test SenseTime’s image recognition alongside Megvii’s software. China’s video surveillance equipment market, excluding home gear, is projected to grow annually by 14% to $20.1 billion in 2023, according to IDC.
“The application of AI has developed very fast,” says Francis Leung, the former chairman of CVC Greater China who invested personally in SenseTime. “It’s beyond my expectations.”
SenseTime is developing similar camera technology for health care, education, logistics and driverless cars. And it’s exploring other markets, which come with attendant complications.In Hong Kong, where SenseTime has its headquarters, the precariousness of the present moment is evident. Protesters have rattled the city for months, provoking the local government by calling for more autonomy from China. The co-founders are predominantly from the mainland, but many are permanent residents of Hong Kong.
Xu, the CEO, has been pushing the company to develop its own AI chips and expand into Southeast Asia, Japan and South Korea. The idea is that even if it loses access to U.S. chips, China will over time develop equivalents via local champions like Huawei, Alibaba (NYSE:BABA) Group Holding Ltd. or SenseTime itself.
He concedes Trump’s blacklisting has rattled some customers and employees. But the process of building a business is similar to academic research -- long and slow.
“Entrepreneurship is a marathon, not a sprint,” says Xu. “We will continue thriving.”
