Back in YY again

The investment case of YY has changed a lot since my analysis back in Feb 2017. The company has in less than 3 years morphed from a highly cash generative “China only” company, to reinvesting cash into overseas high growth (so far loss making) businesses.

As a general point, I really like companies with a core cash generating business, which is then reinvested. If reinvested wisely the company has potential to give fantastic returns to shareholders. YY previously was a deep value and potential dividend case, which attracted a certain type of investors. One issue was that they had not started to return cash, but were rather hoarding it, making the investment case less attractive. Lately they have instead attempted to invest this cash to grow new legs to the business, so far I’m very impressed and that is the main reason why I choose to re-invest into YY.

This time I won’t do a lengthy write-up of the company. A lot has been written by other investors and my old analysis gives a good background to the company. One important component to the investment case that I want to emphasize is the founder David Li. In my view a very special guy in the China tech scene. In many ways the China tech scene is more competitive than the western one. One needs to be very bold, nimble and willing to change your business significantly to survive in this type of fast changing environment. This is one of the reasons why I have always been hesitant to invest too heavily into China tech companies. Something that looks fantastic one year, might be collapsing the next year. I need to see either a significant discount or something very exceptional in the management (preferably both) to invest in China tech companies. I think David Li is the type of character who has shown again and again that he navigated these stormy waters very well. Combining David Li’s track record with a very modest valuation – and I felt compelled to again take a position in YY. Below are two links to better understand David Li’s background and how he thinks.

Interview with David Li, founder of YY: Link to Interview

Tech Buzz China is a fantastic resource to understand China tech. The latest episode about YY’s success outside of China is a good wrap-up what happened since the GGV interview: Link to Podcast episode and another episode on gaming live streaming: link

Valuation

The most logical way of valuing the company is by valuing these three parts:

1. YY Core
2. Huya
3. Bigo

YY Core

This is basically the business in my previous analysis from end of 2017. Live streaming of young pretty girls entertaining the audience and revenue sharing off tips from the audience. It does also contain some other parts like a dating app, which in the past was doing very well. My impression is that the growth has stalled for the dating app, given how little its talked off now compared to two years ago. All in all though, this business continues to be a cash generating machine, spitting out more than 500 million CNY per quarter in cash. The peer in this space is US listed MOMO which is trading at a forward P/E of 15. The outlook for MOMO does indeed look a bit better than YY, for example their Tantan dating app is killing it in the market from what I gather. For a conservative valuation if we use a P/E multiple of 10 for YY and assume no growth in profitability: 500m CNY per quarter * 4 * 10 = 20 bn CNY = 2.84bn USD

Huya

The gaming segment is very interesting and the largest competitor Douyu is also listed on Nasdaq . The gaming segment has shown fantastic revenue growth, but so far very little profitability. This is most likely due to the “war on market share” that has been pretty intense. The last few quarters has seen early signs of profitability. Valuation wise this is easier, Huya is listed and YY owns 45%. The question is only how large the holding discount should be. Many sell side research firms use the holding discount as a “plug”, varying the discount to change their target prices closer to the current market price. That is of course bollocks, but in my view there should be some type of discount. It’s quite common to see holding companies trading some 10-30% below their NAV. So again to be on the conservative side I set the holding discount at 20%. Huya current Market Cap: 4.6bn USD * 45% = 2.07bn USD * 80% = 1.66 bn USD

Bigo

Lastly Bigo, the fast growing short video platform, which currently is still losing money. Bigo which was partially owned by YY in the past, was fully acquired by YY for 1.45bn USD, putting the total value of Bigo at 2.13bn USD. If one wants to be skeptical (which I always try to be) one could be skeptical of the purchase price. Given that David Li was both the owner of YY and separately Bigo, he was kind of transferring money from one pocket to another. So one could question if YY overpaid for Bigo? This is the tricky part of the YY investment case, what is Bigo actually worth?

What we do know is the following development over the last quarters.

2019-Q2:

• Sales 1.2bn CNY

Monthly Active Users:

• 80.7 million from Likee
• 9.6 million from Imo
• 25.3 million from HAGO
• 20.8 million from BIGO

2019-Q3:

• Sales 1.5bn CNY

Monthly Active Users:

• 100.2 million from Likee
• 50.2 million from Imo
• 32.3 million from HAGO
• 21.9 million from BIGO

As we can see user growth is just off the charts for Likee and Imo. If it wasn’t for those insane growth figures, the HAGO and BIGO growth would have been very nice figures as well. Obviously the monetization level of Likee and Imo is very very low, given the modest revenue increase. The monitization potential is also much lower, since many of these users come from poor countries like India. But like we have seen with YY core, a large part of its users are also from rural poor parts of China and then a smaller group of rich clients is driving the revenue generation. Is all about finding the right models to monetize the user base. David Li has stated that he hates advertisement, but for users from these countries this might still be the model. In the latest quarterly report YY notes: “Other revenues increased by 98.3% to RMB408.3 million (US$57.1 million) in the third quarter of 2019 from RMB205.9 million in the corresponding period of 2018, primarily driven by the increase in advertising revenues from Huya and Bigo.” 

To conclude, the revenue potential from this segment is mind boggling with such a user base, it will be very interesting to see if YY manages to retain this user base or if they move on to other apps. Stickiness of users and monitization channels will be key for the value of this segment. If we take the acquisition value of Bigo (2.13bn USD) and divide it by 150 million monthly users, the value per user is some 14 USD. The world leader in short video and YYs largest competitor Bytedance (with it’s app TikTok) is valued at some 75bn USD and has 1 billion MAU. This gives a value per user of 75 USD. Again YY’s valuation does not seem exaggerated. So I will take the acquisition value of Bigo as the approximate value of this segment.

Total Value of YY

So the total value is the three parts above + net cash which is 1.5bn USD.

Value of YY: 2.84bn + 1.66bn + 2.13bn + 1.5bn = 8.13bn USD or 101 USD per ADS. 

 

Warning flags

Looking at the above calculation a very conservative approach still gives significant upside to the share price. So there must be something keeping the stock price down – and probably more than one thing. The issues I can see are:

1. Big question mark on stickiness of Likee/Imo user stickiness, easy come is also easy go sometimes. A user in a poor country is also worth less and many of these millions of users are from very poor background, perhaps having their first smartphone.
2. YY core has stagnated, I might underestimate a potential deterioration in cash generation and competition from MOMO and the likes.
3. Another warning sign would be that even though the company is cash rich in China, the cash seems trapped and can not be used in the overseas expansion. This is an unfortunate effect of the Chinese market, where the government keeps strict control of cross border cash flows. This has been solved by issuing Convertible bonds. The total amount of 500+500m USD have been issued with maturity 2025 and 2026. The conversion price of the bonds are 95 USD per ADS, so this is a stock price level to keep in mind. This dilution has been partly hedged by the company with options at 127 USD per ADS. Knowing this I might be keen to sell my shares around the 95 USD level if the share just reprices without any significant improvements in fundamentals.

Conclusion

The issues listed above are not nearly big enough for keeping me away from this company. YY is founder lead company with a very competent leader. YY has now grown into a much more diversified business which reduced the risk significantly. Not all parts of YYs business has to succeed for this investment case to play out nicely, if just one area continues on the right path the current valuation is already motivated. It’s not either a pure China play anymore. Most of the companies revenue is still from China, but majority of MAUs is from outside of China. I took a 5% position of my portfolio in YY as of Friday close.