Cheetah Mobile (CMCM US) – Value or a trap?

I bought into this company knowing that there was some issues, but believing they issues very minor compared to the values hidden in this company. There were claims the company had conducted click injection in many of its apps. When looking for cheap companies, you sometimes get entangled in some pretty hairy investment cases. In the past I managed to get stuck in companies where there were some serious doubt about their business practices, for example Criteo and Dignity. After some serious contemplation on my side, I in the end decided to exit both those investments. In the case of Criteo, which is trading at all time low, that has been a wise decision. Dignity is trading close to a ten year low, so also in this case, thus far it was the right decision. I think in my speculative investment bucket I have hit another such investment in the case of Cheetah Mobile.  Basically this case boils down to if this company is a fraudulent in its accounting and business practices, or not. If not, it’s an exceptional value investment. I present a short investment case below, short because I ended my due diligence when I had decided if to keep the investment or not.

Summary

+ Large player in the android app space, lately successful mobile game launches.

+ LiveMe #1 Live stream app in the USA, long runway for growth.

+ Historical high profitability of some 80 MUSD/year in cash from operations.

+ Share repurchase program of US$100m over a 12 month period starting in September 2018. Current MCAP 924 MUSD, with 430 MUSD Net Cash.

+ Big strong majority owners (Kingsoft, Tencent)

– Eccentric CEO who always moves into a new things instead of developing the present better.

– Accused of click injection: Click Injection

– Short thesis (Muddy waters style) released on the company: Prescience Point – Cheetah Mobile

Background

The company was established in 2010 when Hong Kong listed Kingsoft acquired Conew Image and merged it’s Security division with Conew. The company mainly based out of China, focused on internet security software, where mobile became the revenue driver. In 2014 Kingsoft spun off this division and floated Cheetah Mobile on the Nasdaq, selling 12 million ADS at US$14 per share. Kingsoft has kept a majority stake in Cheetah Mobile and appointed the previous Conew CEO, Fu Shen, as CEO for Cheetah Mobile.

Business Overview

Cheetah has become one of the worlds largest app producers for the Android systems. Cheetah Mobile has 3 business lines:

This short video introduces some of their most successful products:

Below is an overview split by China and Overseas generated revenue

* Corporate Presentation Q3 2018

 

Financials

Total Revenues

As we can see total revenue have been growing nicely and are also fairly stable.

Revenue Breakdown per product

Digging a bit deeper we can see that utility product revenue is contracting in overseas market, whereas China is growing. Mobile Games and LiveMe are both performing strongly.

Total Expense breakdown

 

Non-GAAP Operating Profit

The Chinese Tech Scene –  a complicated network

Chinese business culture is very much depending on Guanxi. In my view Guanxi is also expressed in the intricate networks of ownership stakes in other firms. Trying to for example summarize all the ownership stakes Tencent made in companies over the years is not an easy task. To really properly do your due diligence, you end up looking at a lot of smaller companies that the large companies hold a share off. It’s common to find long Sum Of The Parts valuation tables when sell side research values the bigger companies. This is a case when sell side research actually is pretty useful, because it’s not easy to untangle all of these stakes in other companies, especially since most of them are unlisted. The investment case of Cheetah Mobile came from such a due diligence process on Kingsoft. As in shown in below ownership pictures, Cheetah Mobile has strong links to the much larger companies Kingsoft, Tencent and Xiaomi. The last two probably needs no further introduction, since they are two of the largest Hong Kong listed Tech-companies. Kingsoft on the other hand is perhaps less known outside of China/Hong Kong.

 

Since Cheetah Mobile has two share class structure, where A shares have 1 voting right and B shares 10 voting rights, the actual voting power in the company looks quite different than the ownership structure. The ADS that are traded on Nasdaq are the A shares.

Cheetah also has close ties to recent tech giant ByteDance (creator of TikTok). Cheetah was an early investor of Musical.ly and held approximately 17.4% of equity interest when Musical.ly merged with ByteDance. In 2017 Cheetah also sold it’s News Republic platform to ByteDance for US$86.6m. Through these transactions Cheetah took payment partly in shares and therefore retains a minority stake in ByteDance. In Q4 2018 Cheetah sold a portion of its stake in ByteDance for US$68 million. This resulted in a disposal gain of US$43m and a fair value gain of US$43 million for the remaining stake in Bytedance. Clearly the Musical.ly investment and News Republic platform have created a lot of shareholder value for Cheetah. The live streaming platform LiveMe raised US$50m from ByteDance in a series B financing.

Presented in a another way, here are the key people in Kingsoft and Cheetah, again showing the strong ties to Tencent and Xiaomi.

Board Kingsoft

Lei Jun (Xiaomi, YY, CMCM)

Pak Kwan Kau (founder)

Lau Chi Ping (President of Tencent)

Zou Tao (On boards of the listed companies: Cheetah Mobile, Xunlei, 21Vianet) – Manager in Kingsoft

Board Cheetah Mobile

Fu Sheng (previosuly CEO of Conew which when acquired he became CEO of Kingsoft Internet Securities Software, before that manager in Qihoo 360)

Zou Tao (On boards of the listed companies: Cheetah Mobile, Xunlei, 21Vianet) – Manager in Kingsoft

Xiao Jie (previously Baidu)

Rui Hao (Director in Tencent Investment arm)

Cheetah Management

Fu Sheng (previosuly CEO of Conew which when acquired he became CEO of Kingsoft Internet Securities Software, before that manager in Qihoo 360)

Xiao Jie (previously Baidu)

Yuki He (founder of Live.me, previously at Tencent and Kingsoft)

Conclusions

What got me interested in Cheetah Mobile the first place was LiveMe’s extremely strong position in live streaming in the USA. On the back of my YY investment I come to understand the live streaming space very well. LiveMe is the clear market leader in the USA and the tipping model of streaming has in my mind a long runway of growth over there. If this was a separately listed company with a similarly reasonable valuation, I would have invested right away. One can compare with YY’s Bigo Live which has a very high valuation, being large in markets with much lower spending power than the USA. But there is really no point to dive deeper into this investment, I have decided to sell my holding. My initial look into this relied on that the majority owners would never let something like this go on their company. In other words, I was not expecting account issues as part of my investment case. I’m still not sure what actually is going on. Although I agree with very little in the short thesis, there is enough there to doubt my investment case. Combined with the click injection suspicions, which also does not seem to be totally unfounded, the stock becomes non-investable to me. This was a speculative holding, where I did not dig deep enough before pulling the trigger and investing. I’m lucky coming out of this around flat, it could have been much worse, since I hadn’t fully understood all backstories of this company.

I still think that there is a good chance, that this company proves everyone wrong, goes up with a few hundred percent. Or more likely just get bought up buy these Chinese giants who already own majority of the company. And then we will never find out the truth. I won’t stick around to find out though. I sell my full holding as of close today.

 

 

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