Description

YY Inc. is a China-based Nasdaq-listed global social media company that currently makes most of its revenues from live-streaming (we’ll get more into that later).  Due to internal growth projects and a new expensive acquisition, the company has ceased to be a stable cash cow and is now a less profitable but faster growing company with a lot of potential future monetization.  The market was not happy with these developments but I believe Mr. Market has overreacted and the price is now too low.

YY has three divisions (YY, Huya, Bigo) and a number of products, all with different growth trajectories, strategies, geographies, and margin profiles.  All are either growing rapidly or cash cows. The profusion of products (and the difficulty in forecasting any single one) make it difficult to make forecasts with much confidence.  However, just looking into the past this company as a whole is organically growing revenue at 31% and yet is trading at a steep discount to many peers at about 1 EV/Sales.  I estimate that before the recent acquisition of money-losing Bigo, YY stock was cash flowing to the tune of 8% FCF yield.  8% is too cheap for a company growing revenues at 31%.

That’s it. That’s the pitch… well the meat of it anyway.  Companies growing revenue at 31% should not be valued at 1x EV/Sales, especially not when they are profitable and cash flow positive. Oh and did I mention a cash heavy balance sheet?  That combination seems too cheap to me and I’m willing to roll the dice.  

If YY puts up some good numbers there is no reason this couldn’t trade to an EV/Sales of 3 over the next 12-18 months, a 200% gain. This is where other fast-growing Chinese internet companies trade.  Some trade far above that. By “good numbers” I mean a simple continuation of recent trends at YY Live (stabilization) and Huya (rapid growth), and narrowing losses with a clear path towards profitability at Bigo.  Management has stated they expect Bigo to be profitable by the end of 2020 and have a history of delivering on their targets. In contrast to a potential 200% gain, the most you can lose is obviously 100% which already makes for a favorable risk-reward.  However, YY would have a very hard time actually going to 0 because net cash is currently 37% of the market cap. Providing additional extreme downside protection is YY’s 36% ownership stake in publicly traded, super-successful, fast-growing Huya. This stake is currently worth 41% of YY’s market cap.  (You can’t add these two numbers together because part of the cash is within held in Huya and you’d be double counting… but cancelling that out they together add to 69% of YY’s market cap… nice).

Oh, and because it is an internet business, YY’s main division has a fantastic ROIC which consistently generates cash in excess of reported earnings.  There is good reason to believe that Huya and Bigo will have similar characteristics when they mature. Huya is already clearly on this path. Cash has been piling up and while there is some question as to what they can actually do with this cash, given it is onshore China, a recently announced buyback may answer that question.

I will first make the case that YY is cheap given its revenue growth profile and then will dedicate the rest of this write up to explaining what YY, in fact, is and going over some of the details.  I have taken the time to untangle some of the financial statements and record key user KPI details which I intend to share and hope will have value for others wishing to do their own work.

A Note on Financials

Shares of YY represent an ownership interest in 3 separate companies.  1. YY, which I will call YY Segment for clarity purposes to distinguish it from YY (the company) and YY Live (its main product). 2. Huya - a subsidiary of YY, formerly wholly owned and now 36% owned and publicly traded, which live streams gamers and e-sports.  3. Bigo, a recently acquired, fast growing and money losing international social media startup founded by YY’s founder and CEO, David (Xueling) Li.

Two things prevent the headline financials from showing the true financial picture.

1. YY fully consolidates Huya on its financial statements but only owns 36% (fully diluted) of this e-sports live-streaming company.  Huya, formerly a division of YY, was spun off in 2018.

2. In March, 2019 YY completed the acquisition of Bigo, a more global version of YY based in Singapore that was founded by YY’s founder and CEO David (Xueling) Li.  Bigo has substantial revenue, is (probably) growing rapidly, but is currently losing money. Thus, unaltered reported TTM figures will overstate profits and understate revenues and growth rates will be inorganic.  Some Bigo financials are available as exhibits in the recent convertible bond filing.

Thus, anything you pull up on Bloomberg or Capital IQ will likely present a (superior) skewed picture.

I believe the only reasonable way to think about company performance and valuation as a whole is to recreate the financials on a pro-forma proportionate (for Huya) consolidation basis.  I.e. subtract the Huya numbers and add them back at 36% of the original to reflect YY’s economic interest. Where appropriate, I have added in Bigo’s numbers pro-forma. The numbers I talk about are these pro-forma proportionate numbers (i.e. numbers that make sense to think about) unless otherwise noted.  Unless otherwise noted I will be quoting RMB which can be converted to USD shorthand by dividing by 7.

YY Looks Cheap to Comps

The bottom line for this pitch is that this company appears very cheap on EV/Sales once you make the necessary adjustments to the financial statements described above.  When you do this, thereby creating revenue history on a pro-forma proportionate consolidation basis, you get 1.2 TTM EV/Revenue with last quarter’s annual organic revenue growth of 31% (below the unadjusted headline number of 67% but still excellent).

Below is a table of some key metrics for a selection of Chinese internet stocks (all data pulled straight from Capital IQ except for YY which has been adjusted per the above).  Obviously some of these are not great comps and there are numerous other factors that are important but this helps to get the lay of the land. I have them sorted by EV/Revenue.

You can see that there are a number of companies that trade much cheaper than YY but they all have negative revenue growth.  (As an aside: I don’t know much about Inke and Sohu and I assume they’re disasters… but how can you not be interested in companies that appear to have negative enterprise values?).  These serve as a cautionary tale of what could happen if YY revenue growth turns into decline (which I do not expect). This is not an investment without risk.

Here is a scatter plot graph of the same companies for EV/Rev and last quarter’s revenue growth rate.

Again, this is an extremely blunt valuation tool but still serves to illustrate how both YY and Huya might be cheap.  None of these are perfect comps but Momo is probably the best.

Below is a similar scatterplot but instead with some prominent US internet and social media companies.  Yes these are absolutely atrocious comps and I don’t expect YY to trade within a mile (and for good reason) but it serves to illustrate the point that with YY you’re getting a lot more for your money.

Sum of the Parts Demonstration

I kind of hate SOTP pitches because they often involve some slight of hand BS and also never seem to work.  I don’t think it’s a good method of projecting valuation because the truth is the market is not going to value these companies by SOTP.  Nevertheless I’m going to do one anyways because it helps demonstrate the structure of the company and why I believe it is cheap.

After subtracting the value of YY’s stake in Huya, and the value placed on Bigo at the recent acquisition, and the est net 10B RMB cash at YY Segment, you get a negative enterprise value for YY Segment.  Now, I’m not going to say, “The market is valuing YY at a negative EV” because in truth maybe the Bigo acquisition was overvalued: Bigo was founded by YY’s founder and CEO and so it wasn’t really an arm’s length transaction, and it occurred at 5.3x sales (though it is growing revenues at ~75% annual rate).  Or maybe Huya is overvalued in the public markets. Also, from a realistic sense, the market is going to put a conglomerate discount on these holdings and I don’t expect that to necessarily change in the near term.

Nevertheless, this helps demonstrate why I think it’s cheap and what could happen if YY Segment achieved a decent valuation.

What is YY?

YY used to be fairly described as a Chinese live streaming company, and it still could be in a sense.  But with the addition of Bigo, it's really more fair to call it a global social media company based in China where most of the revenue comes from live streaming products.

What is “live streaming”?  Just like it sounds, it is streaming a live video of oneself online.  It is super popular in China. Revenue is usually generated by viewers tipping the streamer through a virtual “gift”.  The performer only keeps part of this gift after the platform (YY) takes their cut. I suspect part of the reason live streaming is so popular in China is that TV narratives are more subject to state control and people crave authenticity and spontaneity.  It also may have something to do with the gender imbalance in China and that many of the most popular streams are of pretty girls dancing. I also suspect that part of YY’s low valuation has something to do with it being listed in the US but not really being the “XXX of China”.  There isn’t really a corollary in the US. Facebook Live doesn’t really make any money. People don’t know what Periscope is. Perhaps the closest thing to a live streamer in the US is a YouTube celebrity.  

Most of YY’s products are variants on live streaming, though Likee and IMO at Bigo are notable exceptions, both intend to eventually monetize by introducing people to live streaming.  Though Live Streaming may strike many Westerners as a fad, I would note YY has been around since ‘09 and reported organic revenue growth every year. It is true that there was a huge explosion in live streaming services, and that now there is currently a shakeout in progress.  However continued positive user and revenue growth makes it appear that YY is a survivor. If you are actually into understanding the live streaming phenomenon, I suggest watching the documentary “The People’s Republic of Desire” which you can download on iTunes.

In any case, the company’s various products are best represented in the following grid, which is worth studying for a moment.  You can see there is a lot going on under the hood.

Note the Huya numbers given are for the total segment/company and not YY’s share.  Anything blank is n/a or not given. User numbers in millions. RMB figures in thousands.

Huya

Below are some key starts for Huya.  User numbers in millions. RMB figures in thousands.

Huya is easy to explain as the “Twitch of China”.  People live stream themselves playing a video game and apparently that is so entertaining that other people want to watch it and tip the “performer”.  Go figure. Huya has a rival in Douyu, but the number 3 player in this space, PandaTV, just dropped out. Tencent owns a major portion of both Huya and Douyu, so it would seem they are in a stable duopoly.  Huya is firing on all cylinders, with massive revenue and user growth, expanding profitability, a stable competitive position, and a seemingly long runway. Despite being based in China, it has an international division, Nimo TV which is also successful and it would appear competes with Bigo in some international markets.  Huya is publicly traded so there is a lot of information available.

Though YY currently consolidates Huya’s financials this is probably coming to an end soon because Tencent can purchase additional shares of Huya to reach 50.1% ownership.  This is at Tencent’s option, valid from March 2020 through March 2021, at the average price of the last 20 days. According to IR if Tencent wants to exercise, YY can either decide to sell Tencent enough shares to give them control, or have Huya issue shares for that to happen.  Tencent currently owns 64MM or 30% of Huya shares outstanding, while YY owns 84MM shares or 39% of shares outstanding, indicating that if/when the option is exercised it will be for ~45MM shares to get Tencent to 50.1% of the total approximately 218MM shares currently outstanding.  YY would then own 39MM shares and only 18% of shares outstanding and thus would have to deconsolidate Huya’s numbers in its financial statements. This could be a negative catalyst. Alternatively if YY had Huya issue additional shares, YY would still own 84MM shares of a new total of 308MM, for a 27% stake (but then of course receive no payment).

YY Segment

Key stats for YY Segment.  Most of these were implied via numbers given for YY in total from which one could subtract reported Huya numbers..

The vast majority of YY Segment’s revenues and profits come from their core live streaming product YY Live, which bills itself as China’s leading live streaming platform.  In May 2018 they launched Hago, a “casual gaming social” app which has been growing like a weed but not really monetized yet. Hago basically offers mini games (think something like “Words with Friends” or “Draw Me”) with a social aspect where you can find friends during the app.  It also has a focus on live chat i.e. the mic is on and you chat during the game. YY Live is a cash cow and Hago is an unprofitable growth venture.

A couple things jump out: YY segment revenue growth has slowed and margins have contracted, though they have remained stable over the last four quarters.  The lower margins are attributable to greater R&D, sales, and general management spending. The Chinese live streaming market reached saturation as the pie stopped growing as fast and platforms began fighting each other for share, thus YY has to spend more on marketing to bring new customers to the platform.  Same story with money spent to develop new features to attract users. Competitor Momo has seen a similar margin decline, though their revenue growth has stayed very strong (possible due to their acquisition of Chinese Tinder aka Tantan). Lastly, a large portion of YY’s sales and marketing spending must be from promoting Hago, which isn’t really monetizing yet.  The introduction of HAGO within the last 12 months has obscured what is going on in the overall segment user numbers, but YY Live still had 3.7% yoy mobile MAU growth.  

Unfortunately, YY only reports mobile MAU growth for its various divisions, and not total MAU including desktop.  I suspect this has to do with YY Live losing desktop users, which I would be more worried about were it not for continued growth in paid users (though again the underlying trend in YY Live paying users might also be obscured by the introduction of some Hago paying users users… I see this choice of metric as a somewhat yellow flag).

Bigo Segment

Bigo was founded by YY founder David Li.  YY later participated in a fundraising round for Bigo and then bought the rest of it in March 2019 for a total price tag of 16B RMB.

Below are key stats I was able to assemble for Bigo.  Management has given some annual revenue numbers and I made quarterly assumptions to keep the growth rates comparable.

As you can see, the Bigo segment is fast growing and money losing, and little information has been released so it represents a big question mark for investors  Obviously margins are moving the wrong way as it scales which is worrying (part of this is amortization of acquired intangibles), but management has said they expect it to be profitable by the end of 2020.  In the time I have followed this stock, management has consistently outperformed the targets they’ve set for themselves. What I believe will make this stock “work” is if over the next few quarters they demonstrate that they’re making progress towards the profitability goal without sacrificing too much revenue or user growth.

Bigo segment has three products, Bigo Live, Likee, and IMO.  I’ll cover them each briefly.

Bigo Live is basically  YY Live outside of China, i.e. it is a live streaming app.  They’re focusing on rich countries like Europe, Middle East, and North America.  Bigo Live isn’t fast growing but it is profitable and probably accounts for the majority of revenue within the division.

Likee is basically a copy of TikTok - i.e. a short-form video app kind of like Instagram.  It is consistently one of the top downloaded apps in their core markets of India and South East Asia, though it lags TikTok.  They haven’t really started monetizing yet, but they plan to do so through advertising and introducing people to live streaming.

IMO is a free video and voice calling app - basically something like Skype but it has assembled an impressive 200+ MM users.  Management has been a little vague but IMO actually seems to be a user acquisition strategy. Now they have the users they are attempting to increase engagement by introducing the users to short form video from Likee.  Perhaps best thought of as a WhatsApp type situation: very wide communication-based user base without a clear monetization strategy yet.

YY the company was basically a slowing cash cow before it purchased Bigo.  Now it seems as if all the profits that YY Live was spewing may be devoured by Bigo.  One has to have a little bit of faith that YY/Bigo’s management will make something good out of it.  I believe they will, given that the CEO and rest of the team have a good track record of taking both YY and Huya from nothing to profitable giants in their field.  This podcast with CEO David Li is worth listening to https://podcasts.apple.com/us/podcast/david-li-of-yy-pioneering-live-streaming-in-china/id1336107529?i=1000422432566.  The guy is a rock star and had to pivot many times to turn these companies into what they are today.  Part of the reason YY floundered for a bit was that the CEO and his team left YY to professional management in order to found Bigo.  He/they are back and running the show. With the Bigo founding and subsequent purchase, there has been some questions about the alignment of executives.  However, having a founder CEO in place who owns a 21.4% stake is a better situation than you’ll find at most companies.

Why is YY So Cheap? / Risks

This is always a question worth asking, and the truth is I don’t have a great answer that I have full confidence in.  Here are some possibilities with comments.

• YY Live - the core product - could see a decline in popularity, then revenue, then value.  I have no idea if this is actually imminent, but worry that this scenario is what the current cheapness reflects.  There is definitely a shakeout going on in the Live Streaming industry. Some, such as Inke, have experienced negative growth and have seen their valuations plummet.  Other smaller players, have closed up show completely. As discussed above, YY has definitely seen growth rates for both revenue and mobile MAUs deteriorate… but notably both have stayed positive so far.

• Questionable deals from management.  

• In March 2018, Huya sold a number of its shares to Tencent at $7.16, and then promptly IPO’d in May at $12 and rarely has it been below $20 since then.  In my opinion, the giveaway of shares is pretty understandable because Tencent owns many of the most popular games and trouble with them could have spelled disaster for Huya.  Tencent also owns a large portion of their main competitor Douyu, which no doubt will help stifle bidding wars between the two for top talent going forward.

• Management has done a terrible job of communicating to investors about the Bigo acquisition, which took place at the pricey multiple of 5.3 x sales.  To make matters worse, this was mostly paid YY stock which had just declined 50% over the previous 12 months. This resulted in 22% dilution. This price, of course, was paid to the previous owners of Bigo, the largest of which was YY CEO David Li.  It looks like really expensive self-dealing.  

• The CEO also tried to take the company private in 2015 at $68 a share with the intention to do so and the re-list in mainland China at the encouragement of Beijing.  This came to a halt when the Chinese stock market crashed and new IPOs were no longer welcome (according to IR).

• Turnover of the shareholder base.  Before the Bigo acquisition, YY was a cash cow and clearly cheap on multiples of earnings and cash flow.  Perhaps value investors were turned off by the Bigo acquisition which changed the nature of the combined business and the stock needs time to re-develop a more growth oriented shareholder base.  I’m probably posting this to the wrong forum but when a cash cow acquires a cash-hungry growth engine, free cash flow and EBIT are probably not the correct metrics to value the company any more. This is the situation at YY.

• Investors are afraid of effects of trade dispute.  Certainly, watching the stock from day to day, to a great extent it moves on positive or negative news concerning the trade dispute (to a greater extent than the general market).  YY is not an exporter and so wouldn’t be directly affected and one might imagine these fears affecting other Chinese internet stocks so this can’t explain YY’s cheapness relative to its Chinese competitors.

• It’s a Chinese company in general  Then again, so are all the comps its trading cheaper than.  For those hedge-minded, a pair trade with Momo might be interesting.

Model

Just like I don’t think sum-of-the-parts is a good way to value this company, neither do I think I can model the future very well.  As with all models it is garbage in, garbage out. Nevertheless, I took a very back of the envelope stab at showing what the proportionately consolidated numbers might look like if: 

1. Revenue growth at YY Live slows to 0… though one might think even if user count is flat the growing economy might provide some growth.

2. Margins at YY stabilize near where they are, far below historical.

3. Huya slows due to law of large numbers.

4. Huya margins grow to where a mature live streaming company ought to be.

5. Bigo growth slows but still becomes large and profitable.

6. Cash build is roughly proportional to net income despite FCF being meaningfully higher than net income in the past

I’ll admit I didn’t take the time to proportionately consolidate the historical balance sheet… but Huya didn’t have a very big balance sheet so it shouldn’t be far off.

I believe the above has been made with conservative assumptions.  A very plausible more aggressive model would have YY segment continuing to grow with margins expanding back to past levels and faster Bigo profitability.  I like this company because it is cheap relative to its balance sheet (strong), growth profile (fast), and profitability (would be very strong without Bigo, which has potential), not because I think it will play out exactly like the above.  I’m not sure what metric the market is going to value this on, but for the sake of getting to an answer, if the EV/Sales ratio stays where it is today you can still get to a double in a few years based on sales growth alone. More realistically, if growth proceeds as modeled and the path to profitability at Bigo is established then the EV/Sales multiple moves up towards 3 and beyond and you get a much better result.  I think the possibility of this upside scenario is worth the risks.

Catalyst

• Recently announced buyback.  YY recently announced a buyback of up to $300MM, some 6% of market cap.  Given that net cash is 37% of the market cap, an aggressive completion of this buyback campaign could really do a lot for valuation.  It would put to rest questions around whether YY’s onshore China cash pile (~$1.5B at YY Segment) is worth anything to Western investors and if management is concerned with shareholder value.  We should see an update on this in November when YY reports Q3. This would represent the first buyback activity since 2015 when YY spent 1B RMB to effectively reduce the share count by 3%.

• Bigo reports another quarter.  Bigo was acquired on March 4th 2019 and thus reported partial quarter results for Q1.  It has since reported full Q2 results. If you scale up the stub Q1 revenues by the full number of days in Q1 and compare them to reported Q2, it looks like Bigo had a sequential decline in revenues.  This would be a disaster for the fast-growing, just acquired division. However, Bigo’s Q1 full quarter actuals are available in a convertible bond filing, and when you look at them you can see that quarterly revenues actually grew at a 16% rate (81% annualized).  Maybe no one else is stupid enough to have been looking at the scaled up Q1 numbers but that what I did initially and it gave me quite a scare. Another full quarter should put things in proper perspective.

• Bytedance IPO.  Bytedance, maker of the popular TikTok app is set to go public later this year or next.  When it does, it will serve as a good comp for Bigo, as Bigo’s app Likee is basically a copy of TikTok.  Could help investors do a SOTP analysis on YY.

• Other than that, just the company’s operating and earnings results as we go forward.