|Shares Out. (in M):||199||P/E||13||10|
|Market Cap (in $M):||4,480||P/FCF||0||0|
|Net Debt (in $M):||-951||EBIT||0||0|
|TEV (in $M):||3,529||TEV/EBIT||0||0|
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Momo is a Chinese social media company. Like many Chinese tech companies, it is led by the owner / founder, has a large addressable market, and is run in an innovative fashion. I believe shares are materially undervalued. Within the next year, I believe shares can trade back to the mid-$30’s, offering 50%+ returns from current levels. Below, I’ll briefly describe the industry / business, the financials, valuation, and recent events.
Industry / Business
Momo, up until 2016, was mostly a social media platform that allowed users to interact with nearby users, and had Tinder-like dating functionality etc. (i.e., a stranger to stranger social network). The business was then transformed via the introduction of livestreaming. Livestreaming in China is a massive industry and is quite unique among all forms of social media globally. There are several Street primers on the industry that provide detailed background but, as an introduction, livestreaming takes various forms and can include a girl dancing in front of camera, a cooking lesson, all the way up to a famous singer represented by a talent agency or “guild” making a sophisticated performance. In 2016, when livestreaming was exploding onto the scene, there were a lot of amateur type performances – and there still are – but the trend is now turning towards more professional type content.
Platforms like Momo are also incorporating online games, videochat, short-form video, and other social features and so there is quite a lot of entertainment potential on the platforms. In general, I would say that – similar to how Wechat’ functionality exceeds that of facebook / whatsapp – Momo’s functionality generally makes western quasi-comparables such as Tinder or Twitter’s periscope app look like child’s play. In general, those who follow China internet tend come away impressed with engineering / product development as well as the consumption intensity. This final point is worthy of highlighting – while the Chinese consumer TAM has huge growth potential, existing users are already truly voracious consumers of video entertainment, especially livestreaming.
Additionally, there are some unique cultural aspects inherent in the industry, the biggest of which may be “tipping.” Believe it or not, the largest piece of the monetization model is based on consumers tipping the online performers often by buying virtual gifts or characters (somewhat akin to video gaming monetization). Gifting in such a manner is quite culturally entrenched but for the big spenders, tipping also comes with increased prestige and a sense of connection with the (perhaps famous) livestream performer (“host”). The industry tends to follow the 80-20 rule where 20% (or likely less) of the big spenders contribute 80% (or more) of livestreaming revenue. The same goes for the popular hosts. Usually, livestreaming platforms will keep 50-60% of revenue and the rest goes to the host. Also relevant here: China has a gender imbalance and hosts skew largely towards women and tippers towards men.
So there are certainly some peculiarities within the model and what drives it – and this brings about some caution from U.S. investors – but I believe the model is durable. Livestreaming / tipping is actually a fantastic monetization method (far better than advertising or low-arpu monthly subscriptions although Momo also has segments that capture those revenue streams). Illustrating this, Momo will generate $1.3 bn of revenue this year (similar to Match Group and more than half of Twitter) while livestreaming ARPU was ~$24 in the recent quarter, with the big spenders likely spending thousands over the quarter.
As for competitors, YY is the most direct competitor but there are numerous others. Momo (before its recent decline) was generally thought of as one of the best (and stickiest) platforms given its extensive social features and social legacy. I still think these attributes exist and will serve Momo well going forward. While livestreaming is less of a “craze” in China in 2017 (as compared to 2016), Momo and YY are still growing MAUs, increasing user monetization, and are pulling users away from the weaker fly-by-night VC-funded competitors. Momo is likely having some growing pains around transitioning to more professional content but has still demonstrated massive growth this year (I’ll discuss some highlights later).
While the business discussion above isn’t exhaustive, it hopefully provides an overview of the salient features in what may be perceived as a non-traditional business. At the end of the day, I regard Momo’s model as just another form of entertainment, and it bears resemblance to many industries including traditional social media, TV, casino-style entertainment and spending, etc.
Financials / Numbers
The company reports a pretty simple set of financials, which I’d refer the reader to. Livestreaming is the main driver but Momo also collects revenue from subscription services (VAS) and advertising. These streams are smaller and so I will omit a lengthier discussion here but I’ll note that (a) advertising is currently depressed as Momo has reduced their ad load by a factor of 3 while they look to build a more quality viewing / advertising experience and (b) VAS revenue is growing nicely already but has continued opportunity to outpace user growth as Momo is becoming smarter about adding new social features that incentivize subscription purchases and gift-giving outside the main livestreaming arena. This diversity of features (dating, chatting, gameplaying) helps keep users in the Momo ecosystem.
I will discuss some of the key metrics further in the next section when I attempt to explain the fear around the stock. However, here are some highlights for income and KPI’s to support that discussion:
· Generated 38c / 45c of gaap / non-gaap EPS in the most recent quarter (which annualizes to $1.80 of EPS, on a non-gaap basis)
· Generated ~$1.50 of TTM gaap EPS
· Operating cash flow outstripped net income by 36% during the ttm period as Momo’s model has strong cash flow characteristics.
· The upcoming 4Q revenue was guided to +53% YoY growth at the midpoint, or greater than +6% sequential growth. So, growth is still healthy.
· 2018 consensus calls for $2.15 non-gaap eps.
· MAU’s grew to 94.4 mm (91.3 prior quarter, and 77 mm prior year so 3.4% sequential MAU growth and 22% YoY growth). See further discussion in next section.
· Livestreaming paying users of 4.1 mm, flat from each of the past two quarters. See further discussion in next section.
· VAS paying users of 4.8 mm (up nicely from 3.4 mm the prior year and 4.5 mm the prior quarter).
Moving on to potential points of worry contributing to recent price action, I would mention…
· Livestreaming paying users have been flat the past two quarters. As mentioned, livestreaming is the monetization golden goose and no growth here is optically scary. Management points out that some lower end users are shifting monetization into the VAS bucket and when viewed holistically, we still see aggregate growth in these two buckets. Additionally, Momo underwent a marketing change in the prior quarter (see call transcript for discussion) and this had the effect of slowing user growth as the changes were being implemented. I generally regard both these explanations as credible. Further, management discussed the top cohort of paying users still increasing nicely – and this is the point that I’d reiterate. Recall first that I mentioned that the 80-20 rule earlier. Next, observe that this quarter still saw terrific livestreaming revenue growth (both YoY and QoQ) despite the flat paying users. So, what’s happening is that because a paying user could be a $5 tipper or a $5,000 tipper, the headline 4.1 mm livestreaming users is an imperfect metric in capturing growth potential. Management has indicated that they are actually still growing the top tier users (i.e., the big spenders within the 4.1 mm) as well as gaining ARPU on that cohort and this is what likely drove the nice revenue increases despite reported paying users remaining flat. Having that cohort (perhaps less than 1 mm users) growing healthy is more important than whether 4.1 mm total paying users becomes 4.3 or 4.5. Investors might not like the dynamic of the non-homogenous P*Q revenue model but that doesn’t mean the business isn’t healthy. Moreover, I’m optimistic MAUs will reaccelerate upon management finetuning the marketing channels. Additionally, I expect the roll-out of additional product features should keep retention high and the overall ecosystem strong.
· MAU growth has slowed in the quarter. I’m not overly concerned here. +3.4% sequential growth isn’t bad, and the earlier marketing point provides further context. Management is renewing their focus on quality users and explained that retention is increasing. I’m sure management could ‘goose’ the MAU count (or have managed to increase the livestreaming bucket instead of the VAS bucket) but I like that they’re focused on quality and not managing metrics. Additionally, it’s worthy of highlighting the absolute number here – Momo has 94 mm MAUs. This is a huge number already, though the company believes the addressable market is several hundred million. So, the growth runway – even if not perfectly smooth – is very large.
· Margin. Gross margin is trending down and this will continue as Momo invests more in high-quality hosts, often represented by agencies. However, savings in SG&A – which is elevated this year due to a branding campaign – should offset the gross margin contraction and overall operating margin should hold.
· Lastly on the potential worry-points, Alibaba and Jack Ma’s investment vehicle (Yunfeng) are both large shareholders but seem to have entered ‘sell-mode’ since late last year. Within the recently reported quarterly release, the board members from Alibaba (Joe Tsai) and Yunfeng stepped down for “personal reasons” but this leaves room to speculate why they’re bailing. I don’t have the definitive answer nor any unique insight here, but I don’t think this is determinative of the company’s fate.
I think the $2.15 of 2018 consensus is a reasonable figure, though I do believe there will be sustained growth into 2019 and beyond. But let’s stick with the 2018 figure for now. Attach a 13x multiple (I also think this is conservative for a growing social media business, with attractive monetization and strong cash flow) and that gets you $28 / share of value. Add on $6.50 of YE’18 cash and you’re at $34.50 per share, which I think could be a conservative valuation but represents ~53% upside from the last close.
If the business reaccelerates MAU / paying user growth, and effectively solidifies its growth profile and investor perception, then 15x 2019 EPS plus then-cash could result in a $50 stock or >100% return. If earnings languish / revert to the TTM GAAP level of $1.50, then 9x EPS + next year’s cash would result in a $19.50 share price or -14% down. I think this is a favorable skew and the current market price would appear to be pricing in some negative scenario that I don’t see justification for.
As somewhat of an aside to valuation, one can compare Match Group / Tinder to the Momo numbers I mentioned in the prior section. Match Group has ~6.6 mm paying users, with 2.5 mm at Tinder, which has perhaps some-odd 30 mm MAUs. As can be seen, Momo’s user numbers are larger. Income-wise, both companies will generate a similar $1.3 bn of revenue this year, while Momo is expected to notably overtake Match on the net income line in 2018 (~$450 vs ~$350 mm). Yet despite this, Match now sports an EV of $8.9 mm vs. MOMO at $3.5 mm (so MTCH is 2.5x as large). While these companies aren’t apples-to-apples (I actually think Match / Tinder are likely envious of Momo’s features and ecosystem), I think the comparison illustrates the value at Momo.
Regulatory exposure? A: there is some, as the government keeps a tight lid on any indecency and unhealthy societal behavior (see restrictions on gaming time-spent for youngsters), but Momo isn’t a political forum by any means and large platforms (such as Momo and YY) have the best capability to monitor content. I don’t think the government should mind a couple large, monitorable platforms that provide harmless non-political entertainment to the male masses.
Livestreaming is a fad? A: I think not. The industry will evolve and may need to shed some of its lower end users / hosts but seems too powerful to be a fad. Alibaba investors may note that BABA is ramping their livestreaming efforts as pertains to shopping (product demos etc. as they’ve found it to be a highly engaging call to action vs. simple video).
Lots of competition for eyeballs? A: this is true. It’s amazing how many 50 mm+ MAU social media companies exist in China. However, Momo is a real contender and while there is significant competition, there are also a lot of eyeballs to go around in China.
Management / Board risk? A: Given the jurisdiction, I can’t entirely rule out non-shareholder friendly behavior, but this company has been around a while so there is a body of work to assess and I don’t view the risk as particularly elevated. Around the time of the IPO (2014), Momo’s CEO was accused of stealing important IP from Netease and so that was a somewhat ugly episode but nothing much ever really came of it. As mentioned in the prior section, the BABA backers have sold down shares and recently left the Board so this leaves room for one to speculate but I think there could be numerous benign reasons for this as well.
User growth turns negative? A: I touched on this earlier so I won’t repeat. I just don’t see it happening and the stock is cheap in my mind ex-growth (although growth is still required for this to work).
Unknowns / Falling knife? China tech has been miserable the last couple weeks and it’s not uncharacteristic for such names to trade irrationally. Yet, I am still surprised by the downward price move since earnings.
I think (a) reacceleration in MAU growth upon finetuning of the marketing channel (b) re-ignition of livestreaming paying user growth and / or (c) simply posting continued, solid revenue growth quarters would go a long way to reassure investors of the company’s durability. If this occurs, perception could improve swiftly. Management once tried to purchase the company and perhaps that’s more likely to be allowed today than a couple years ago. Given the livestreaming monetization power, the social elements, room for adjacent growth into dating, and the vastness of the China internet growth story, I think this is quite a unique and attractive asset.
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