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.

 

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Further China reduce – Sell YY

I have had a extra close eye on YY for a while now. The reason is that it had surpassed my conservative valuation in my analysis (YY Full analysis) of 56 USD. Actually I still wanted to squeeze out some more of the juice and believed we could see the stock trading up towards 70-80 USD. Especially considering how well other tech stocks are doing. But one of the concerns that I listed was a potential government crackdown on live-streaming. This is also something mainland Chinese people have warned me about when I have discussed the YY investment case. As an investor in China I have the fullest respect for what the government says and plans to do, in-fact many of my investment has China’s long term plans as a nice tailwind for the investment case.

On the 22 June a State administration announced it had requested to suspend several video portals due to lack of licenses. The largest company affected was Weibo and two others, this was not at all related to YY. Later on information came out that the number of services that had been named was larger than the initial 3. Today before opening the market realized this crackdown is more serious than initially expected. I haven’t myself managed to get to the bottom of this, just reading news articles like these ones:

SCMP – Weibo disables video uploads longer than 15 minutes, amid regulator scrutiny

Chinese authorities put the brakes on a surge in live streaming

Quite often these things just blow over, forgotten in 3 months and everything is back to normal. But sometimes it’s the real deal and nothing will be the same again. Given that I reached my target price and YY has not traded down drastically on this, I take it as an opportunity to both further reduce my China exposure and sell my holding close to my base-case target price, and a very healthy profit.

 

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YY.com – Full Analysis

General Intro

This is a follow-up on my previous post where I initiated a position in YY.com. I have already directed you (Here is the link again) to an excellent article on the whole live-streaming phenomena in China. As I stated before, I believe in this going forward both as a phenomena and YY’s revenue model of virtual gifts. I think this works especially well in China where the people aged 15-35 spend more and more of their time in front of computers/video-games/mobile phones. A lot of people are getting seriously dysfunctional in normal social interaction and feel loneliness. The need to interact is still there and these platforms become the ultimate way to relieve that frustration. On top of that we have a lot of old people, who also feel lonely, especially in China where the one child policy has created a lot of elderly which don’t have a big group of youngsters to interact with. In the case of YY, it’s also a city tier story, the people living in Tier 3 cities are very curious of the lives of people living in Tier 1 cities. Digging in to the figures the best future prospects for revenue growth comes from online-dating and educational platforms. But let’s not get ahead of ourselves, let’s move over to the company Intro.

Company introduction

The founder David Li has a long history in China Internet Tech. In 2003 David worked for Sohu as the IT head editor, later he join NetEase. In 2005 David start his own business duowan.com, the homepage quickly became China’s largest game information website, with over 100 million page views per day. Mr. Lei Jun, an angel investor in YY is was the CEO of Kingsoft Corporation later he founded XIAOMI technology-a smart phone company, Lei Jun is considered among China’s 10 wealthiest. David Li and Lei Jun owns both about 17.5% of the company each. In July 2008, the company launched the YY Client, a PC-based software that allows users to create individual channels for any live social gatherings. YY Client quickly gained a vast user base and emerged as one of the most popular voice communication tools. In 2010 a mobile app Mobile YY was introduced and in 2012 a web version. YY was listed on the NASDAQ in November 2012.

It should also be mentioned that David Li and Lei Jun quite recently tried to take the company private: “YY received a non-binding “going private” proposal from its Chairman Mr. Jun Lei and its CEO Mr. David Xueling Li, proposing to acquire all of the outstanding shares of YY for US$68.50 in cash per American depository share (ADS).”

yy_perf_graph

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YY.com in Ctrip out

To not increase my China exposure, which is at somewhat uncomfortable high, I decided that for every China exposure holding going in, another one has to go out. This means to make space for my new holding YY.com which I’m very excited about, I have to throw out one. The Chinese holding I have not yet done a full due dilligence on is Ctrip, and for no other reason than that, it is the weakest card in my portfolio. So out goes Ctrip in in comes YY.com at the same dollar values (approx 5% weight), as of today’s close.

From Vlogs to Live streaming

I have been very fascinated about the whole Vlog (Video log) scene, and how big it has grown in just a few years in western countries. I find myself watching more and more quality content on YouTube, but also spending more time on “crap”. With crap I mean following some person through their daily life or just someone doing silly things online. China has managed to take this to the next level through online streaming, where hosts interact with their audience. YY.com and their competitors have implemented a very clever system in terms of how viewers pay. I’m very sure people get hooked on it, and I’m sure we are just at an initial stage of growth. What I’m less sure of is if YY.com is the right horse to bet on, but as far as I have been able to gather, they are. As I said I’m excited about this holding and I hope to find the time to write a full report on the stock this weekend.

Until then, this is a very excellent piece on the topic and I will base a lot of my post about YY on this article: Livestreaming Trend in China

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