Momo (MOMO) is an ‘open’ social network in China. Lead by top-notch management; it has become a top player in the online live-streaming and dating market in China. The long-term industry outlook points to a very bright future for the company.
Despite this, the market has turned sour due to the short-term blip in performance of the company. The social impact of Covid-19 has stopped abruptly the growth of Momo’s top-line and user base. While the effect is temporary, the market was quick to discount the stock to $3.5B market cap, and enterprise value to $2B.
We strongly believe the stock market has overreacted. It forgets that even though Momo is still focusing on growth, the company has already achieved economies of scale and is barely getting started on monetization for its star app – Tantan.
Moreover, the trend in the industry is favorable. The target market is young, growing more prosperous, and getting more accustomed to dating online. Thus, even if this segment of the industry is competitive, there is room for multiple winners. If anything, fierce competition at this phase of the industry life cycle is a good sign that there is lucrative untapped demand to be met.
We believe this is a chance to build a position on the stock, currently trading at $18/share.
Momo Q1 results were poor
Momo reported the first y-o-y revenue drop since IPO. Net revenue decreased by 3.5%, to RMB3,594.1 million (US$507.6 million). The main culprit was nothing else but Covid-19.
The management explained that prolonged social distancing and lockdown measures turned people off from online dating. Logistically, users from the second tier were also unable to return to first-tier cities for work after Chinese New Year. As a result, top-paying entertainers/performers couldn’t contribute as much joy to the platform. Unsurprisingly, new user subscriptions and engagement fell.
Q2 is predicted to be worse as the impact of Covid-19 weighs heavier on user’s consumer disposable income and sentiment.
[…] the company expects total net revenues to be between RMB3.8 billion to RMB3.9 billion, representing a decrease of 8.5% to 6.1% year over year. This forecast considers the potential impact of the COVID-19 outbreak and reflects the company’s current and preliminary views on the market and operational conditions, which are subject to change, particularly as to the potential impact of the COVID-19 on the economy in China […]
Source: MOMO’s Q1 2020 results
Taking a long-term view
Now, Q1 was bad, and Q2 will probably be worse. However, we have reasons to believe that once Covid-19 problems are over. Momo will return to growth. It has two levers to pull, either attract more paying users or increasing the amount each user spent.
For now, user growth is muted. However, ARPPU (average revenue per paying user) shone. It was the main reason why Q1 net income increased by 86%, to RMB538.9 million (US$76.1 million) from RMB289.3 million in the same period of 2019.
This shows that even as the community was not growing in number during this challenging period, existing users were enjoying the social experience on Momo and importantly, happy to pay more.
We believe Momo is not even getting started on maximizing ARPPU. From Q1, we know that ARPPU was boosted by new features (e.g. FlashChat), paying scenarios (virtual gift business), and shifting revenue mix more towards higher ARPPU per subscriptions. Additionally, Q1 saw more new users converted to paying customers.
Tantan is only getting started
Then, we have not even mentioned about Tantan. We believe Tantan has better potential than the Momo app.
Tantan is already a top dating app in China. Its potential for growing its user base and increasing ARPPU is many times its current 4.2M paying user. The reasons are threefold.
First, the target market for Tantan is ripe for exponential growth. The population is young, internet-savvy, yet the stigma around dating online means that the market is still underpenetrated.
Secondly, the average age of its user base is only in the early 20s, by growing into the workforce and earning higher disposal income, Tantan has a long-term tailwind to grow its user base and ARPPU.
Finally, the road map to grow Tantan looks like a win-win for users and the company. Unlike Tinder, the management wants to move monetization beyond the subscription model into ‘a la carte’ sales. Thus, the management wants the user to have more ways to engage with other users rather than just growing the community in size. An area that Momo already has extensive experience from the Momo app.
Of course, this strategy’s success relies on the ability to figure out the right a la carte experience—for example, different ways to interact, types of gifts, and immersive experiences, however, it will remove the ceiling for ARPPU.
Liquidity and balance sheet
There is no question the road to success will be challenging. To support Momo’s effort, the company has accumulated a mountain of cash.
As of March 31, 2020, Momo’s cash, cash equivalents, and short-term deposits totaled RMB15,467.2 million (US$2,184.4 million), compared to RMB14,925.3 million as of December 31, 2019. Net cash provided by operating activities in the first quarter of 2020 was RMB543.5 million (US$76.8 million), compared to RMB1,175.9 million in the first quarter of 2019.
Source: MOMO’s Q1 2020 results
All the resources and potential presented would mean nothing if the management can’t execute. While we can’t predict the current team can deliver. They are indeed an impressive group of managers. Almost all had roots from NetEase (NTES) in various stages of growth. Additionally, the management has a substantial interest in the company as insiders share ownership currently stands at 42%.
Source: MOMO 20-F FY2019
Momo has been on fire since its IPO, taking the Chinese live-streaming and dating market by storm. While its achievement to date has been impressive, Q1 shows that things can turn sour very quickly, and the market punished the stock, disregarding its long-term future potential and track record in generating cash.
We are very bullish on the prospect of the company. The poor Q1 results uncovered many positives. First, Momo successfully turned negative top-line growth to higher bottom line profit, demonstrating strong execution and ability to achieve economies of scale, a trend that has been brewing since IPO. Q1 results put a spotlight on this achievement again. Secondly, its star app, Tantan, has so much potential. If executed successfully, it can be the poster child for Momo like Tinder to Match (MTCH).
Meanwhile, the company has ample financial resources to support future growth. It’s unbelievable to be able to invest in a company at $2B enterprise value that generates $2B in sales, $450M in operating profit, prints $650M of cash in the last twelve months and has a net debt cash balance of $1.5B.
Disclosure: I am/we are long MOMO, HUYA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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