As my loyal readers know, I have written quite a few articles about Momo (MOMO). I selected it in July 2017 as the third pick in the Potential Multibaggers series, and I have written six updates since then.
One of the reasons I have written about the company so frequently is that the stock price has been all over the place since that first pick:
Momo clearly has not been a winner for the Potential Multibaggers Portfolio. I am not worried, though. The Potential Multibaggers still beat the market by more than 20%. And losers like Momo are inherent to the system I use. A few excellent choices wipe out the losses and make you outperform the market by a wide margin: Shopify (SHOP) is up 257%, Baozun (BZUN) 115%, and Okta (OKTA) 70%.
Just because Momo stock price is down doesn’t mean I don’t believe in the company anymore or that its story has fundamentally changed. To the contrary, I still own the stock with a high conviction that over the long term it will turn out to be a great investment. After all, this is what the total revenue has done over the period that I have held Momo in my portfolio:
The revenue went up from RMB767M to RMB1.9B, up 147%. If there are bumps in the chart, it is in the chart that reports in dollars. The Koyfin chart that I have used above is in yuan, and it clearly shows the steady growth of Momo’s revenue. So, while a lot of investors are maybe afraid on looking at the price chart, the story is completely different if you look at the fundamentals.
The issues Momo is facing
There are several reasons why Momo has been so volatile. The one best known to any investor is, of course, the trade tension between the US and China. Investors are uncertain how this will turn out for China, and therefore, a lot of Chinese stocks are down quite a bit from their highs. Momo is no exception.
The most recent drop, however, wasn’t the direct result of that tension. On April 29, 2019, Momo made it public that it had been made aware that certain mobile app stores in China had removed Tantan and that this was done on the orders of Chinese governmental authorities.
(Logo of Tantan, Google Play store)
Momo also announced that it was already in talks with the relevant authorities to understand what the problem exactly was. The company said it would fully cooperate with the authorities to bring Tantan back in the app stores as soon as possible.
This is what Tang Yan, Momo’s CEO, had to say about that challenge on the Q1 2019 earnings conference call:
Although Tantan recently had some regulatory issue that we need to work hard to address according to government directives and will have a negative impact on user and business growth in the near-term. We believe that the self inspection process is going to be helpful in making sure that the Tantan community develops in a healthy environment.
I’m confident that after these temporary challenges got passed, Tantan will continue to grow larger and stronger to be the platform of choice for dating in China. We still have high conviction that Tantan will become a significant growth driver of the company in the coming few years.
I agree with this statement. Bans are more or less the Chinese equivalent of fines in the EU and the US: they are carried out to make companies listen to what governments want. Nothing to be too pessimistic about, just a means of punishing unwanted behavior.
Two weeks later, on May 10, Momo took another blow when it had to suspend newsfeed posts between May 11 and June 11, again because of the government. This is what Tang Yan had to say about that:
And based on our observation and based on the data that we’ve seen from the past two weeks after the inspection started, we do expect that user engagement mainly represented by total time spent, number of interactions and number of relationships formed to see pretty meaningful decrease during the inspection period. DAU is also going to see some level of decrease, but to a much less degree than total time spent. And of course the decrease in user engagement and DAU is also going to cause the paying users of the platform, especially the VAS paying users to decrease during the inspection period. However, we do expect these engagement metrics to gradually start to resume growth after inspection period is over.
No minor issue here, but it’s still not very clear what the impact will be. Here’s Tang Yan again:
The impact from the above-mentioned regulatory issues on Momo and Tantan user engagement can be directly or indirectly translated into revenue line, which have been fully reflected in our Q2 revenue guidance.
Momo’s guidance for Q2 2019 was within the expected range (RMB4B to RMB4.1B, up 27-30%), and so, the impact will be rather small, I suppose.
As long as the problem is contained to one month, Momo will survive and thrive. And Tang Yan said about the communication with officials:
And so far we’ve been very proactively driving the self inspection process as according to the requirements from the regulators and we’re moving forward in a very solid manner. And at the same time, we’ve also been maintaining very smooth communication with the regulators.
I think management communicates well with its investors and will try to avoid any problems for the future.
The financial results in one word: Great
Momo is facing a lot of headwinds: two regulatory events in just a few weeks which suspended two important elements of the company, the macroeconomic environment, a very competitive advertising market, the gaming licensing freeze that has not been swallowed completely. And yet, the financial results were outstanding.
The total revenue came in at RMB3.72B, up 35% YoY. Tang Yan named the rapid growth of Momo’s virtual gifting service as well as Tantan subscriptions as two important contributors. This is great news, and it further diversifies the income stream of Momo.
We have seen when we researched Weibo (WB) and when we looked at the results of iQIYI (IQ) and Baidu (BIDU) that the advertising business is in a major dip in China. Fortunately for Momo, only 2-3% of the total business revenue comes from advertising. To show you how bad it is: mobile marketing was down 32% YoY. The freeze in gaming licenses last year still has an impact as well: mobile games fell 8% YoY.
The big highlight offsetting these losses was VAS revenue (Value Added Services). It came in at RMB903.8M, growing a whopping 285% YoY. VAS only started two years ago, in 2017, but it already contributes more than one-third of the total revenue of live broadcasting. The VAS revenue is mainly from digital gifts.
Wang Li, Momo’s COO, said on the Q1 2019 earnings call that this was actually just the start of VAS and that there are huge opportunities left:
Although during the year 2017 and 2018 we have made a lot of progress in diversifying the paying experience for VAS, we believe we still have a long way to go. For example, the chat room experience, which is the biggest in terms of consumer penetration among Interest Group, Quick Chat and Party as well as Werewolf is currently under – is still currently under monetized. We will keep testing different paid services that truly enhances the social experience for the users. As we do so, Momo’s VAS revenue will continue to grow as well.
And the company also wants to diversify its user monetization further. Again here’s Wang Li, from the Q1 2019 earnings call:
The middle cohorts grew significantly faster year-on-year than the top 500 paying users. In March 2018, the top 500 contributed more than 30% of the year-over-year growth. In March 2019, that number has dropped to low teens, substantially lowering our risk exposure to the macro uncertainty.
For any social media platform, user growth is very important. Here too, Momo could present excellent results. The core Momo app had 114.4 million MAUs (monthly active users) in Q1 2019, up 11% YoY and up 1.1 million QoQ. Quarterly, the growth was slower than in previous quarters, but that had to do with the negative impact from Chinese New Year, which Momo sees every year.
The total number of paying users for the core Momo app was 9 million, up 12% YoY. QoQ, they were essentially flat, also because of the Chinese New Year. The company expects the number of paying users to fall somewhat because of the one-month prohibition on the newsfeed, but it expects it to rebound shortly after this has ended.
TanTan: Firing on all cylinders despite the problems
TanTan reached a milestone by hitting 5 million users in Q1 2019, adding 1.1 million QoQ, an impressive growth of 28% new users. And there is still a huge open road for TanTan, in my opinion. There are a lot of people who work far from their hometown in China. These people are a huge market for TanTan. Yes, there still is still a bit of a taboo around the subject, but the same was true in the West and look at how youngsters use dating apps now.
TanTan uses the same approach now as the Momo app: by rolling out premium services (comparable to See who likes me in Tinder), but also by using VAS-like virtual gifts. What better place, what better time to give someone virtual gifts than on a dating app when you try to court someone? Again, huge opportunity, I think. And here too, there is diversification of income: not just subscription, but also VAS. This is what Wang Yu, founder and CEO of TanTan, said on the Q1 2019 earnings call about growth opportunities:
As the Tantan community continues to expand, we do realize that we have an increasing number of users who have a strong willingness to pay more for a better social experience that are currently underserved on that front.
Despite this good news about TanTan, there are also headwinds. Not only was it banned from the app stores, but in early May, Apple (AAPL) suspended the in-app purchase service for the iOS version of TanTan. Here’s what Wang Yu had to say on the Q1 2019 earnings call:
As most of the subscribers had an auto-renewed subscription on a monthly basis, the suspension of the payment service on iOS is going to have a pretty meaningful impact on a net number of paying users and revenues for the second quarter of 2019. As we currently do not have full clarity on when Tantan’s download service can be restored, we’re making Q2’s revenue estimates, we tend to lean on a conservative side by assuming that the suspension of download service and the in app’s purchase on iOS will last throughout the second quarter. Negative impact to revenue based on such assumptions have been fully reflected in the company’s guidance.
Now, don’t compare this to Apple in the US. While iOS has a 47% market share in the US, it only has a 25% market share in China. Still, this is no minor issue, of course. Over the long term, though, I think this will prove to be a temporary problem.
At this moment, TanTan contributes less than 8% of the total revenue for Momo. That means the risk from TanTan to Momo is limited. But over the long term, the potential is huge. Even international expansion in the rest of South East Asia is a possibility. TanTan seems to be popular in India. For now it is not a priority at all, but it shows the many options TanTan still can use.
Momo’s guidance came in at RMB4B to RMB4.1B, which means a growth of 27-30% YoY and 7-10% QoQ. These numbers show that Momo is still growing like a weed, despite the headwinds that it faces with the removal of TanTan from the app stores, the suspension of Momo’s news feed, and the impossibility of making in-app purchases in TanTan. Besides that, the company has a total of RMB12B on its balance sheet, which still is $1.74B, despite the unfavorable currency translation.
These are a few of Momo’s ratios:
A ttm P/E ratio of 17.35, a forward P/E of just 9.73 and EV/EBITDA of just 8.15? What is this? A bank that has barely survived the financial meltdown? No, this is a company that is expected to grow its revenue by more than 20% for years to come.
This is a company with a PEG ratio of 0.61. That is incredibly low. If Momo would have a PEG of just 1 (so the P/E is the same as the expected growth over the next few years), your return could be almost 40% annually for the next few years. This stock is dirt-cheap! And it has a great management team, is innovating, has a strong users base and is still growing at a very high rate. Do you see now why I’m not thinking of selling Momo anytime soon? For me, the story has not fundamentally changed, just the price has.
As far as earnings go, Momo is still firing on all cylinders. The fact that Tantan is temporarily blocked in app stores will not change that, especially because the impact of Tantan’s revenue on the company’s revenue was only 8% in the last quarter.
Momo has $1.74B on the balance sheet, is expected to grow its revenue at 27% to 30% in the next quarter (and possibly for quite a few quarters after that) and has tons of optionalities left. VAS has only started two years ago, and TanTan has the potential to be a great contributor to Momo’s revenue over time.
In the meantime, the shares are on sale again. With a forward P/E of 9.73, this stock is punished by the circumstances. For long-term investors with a lot of patience, this might be the moment to accumulate a position. For those who own already shares of Momo, like me, I think it is very important not to look at the outside (the falling stock price) but at the inside (the company’s fundamentals and earnings are still outstanding and show no slowdown).
Because of the issues Momo and TanTan have had, you might think this is a problem stock, but the contrary is true: it is still growing at high speed. This stock has greatness, but it is disguised by the recent issues which are temporary and not that impactful. The proof is in the guidance. In a quarter where the three headwinds play in full force, the company expects revenue growth of 27-30%. Amazing! Momo is greatness in disguise.
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In the meantime, keep growing!
Disclosure: I am/we are long MOMO, SHOP, WB, BZUN. 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.