Jan 30 2020 - Skirt The FOMO; Pick Up Some Momo

Summary

Momo has a great business model that dominates in an attractive industry in an awesome market.

We believe the upside for the stock is in the 200% range over 2-5 years as the company continues with fast earnings growth.

There have been numerous obstacles for Momo over the past couple years, including the current coronavirus in China, which have kept the share price subdued.

Compared to Match Group, and based on growth prospects, Momo is an incredible bargain.

Introduction

Despite excellent growth, Momo Inc. shares (NASDAQ:MOMO) can be purchased at a depressed price due to a series of back-to-back events over the past 2+ years.

It's been a while since I've written an article on SA. I decided in 2016 to only write when I believe there is something very strong to offer rather than writing to attempt to gain followers through regular writing. I'm more concerned about the performance of my picks than how many I produce. That has put me in a conundrum over the last couple years. As lauded stock picker Meryl Witmer recently quipped in a Barron's article, "It's been pretty slim pickings for the value investor." I did a deep dive in the energy space for a year or more, and I feel confident that I found the best stocks in the sector. But I cannot tell you any better than a coin toss whether or not they will generate a gain five years from now. I also wrote a book over the past couple years, published just last month called Joe's Dynamic Investments, 5 Principles to Creating and Maintaining Wealth.

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Today, one of my favorite long-term investments is MOMO Inc. headquartered in Beijing, China.

The company's website describes the business operation as follows:

"We enable users to discover new relationships, expand their social connections and build meaningful interactions. We connect people and facilitate interactions based on location, interests and a variety of recreational activities including live talent shows, short videos, social games as well as other video- and audio-based interactive experiences, such as live chats and mobile karaoke experience."

The above description of business activities may seem long-winded. In the U.S., we call it an online and mobile app dating site. Momo might be compared to Match Group (NASDAQ:MTCH) in the U.S., though with cultural differences such as substantial revenues from virtual gifts and streaming. The revenues of the company are stable and growing. In 2018, the company acquired a mobile app called Tantan for between 0m to 0m - a very important bet on the future. Tantan is a Tinder-like app that is hot among young Chinese singles. Both MOMO and Tantan use a "freemium" business model which allows users to sign up for free before monetizing the user base.

Revenue Growth

Momo reported an impressive Q3 with 114m monthly active users (MAUs) on Momo. More importantly, monthly paying users of the company's live video services were 13.4m users for Q3 2019, compared with 12.5m users for Q3 2018. The company showed significant growth in its virtual gifts business on the Momo app. All totaled, revenue increased by 22% YoY in the quarter.

Why is MOMO Attractive/Growth Drivers

The company's guidance is for around 25% revenue growth going forward. That is attractive in and of itself of course. But how will they achieve it? Momo, with the inclusion of Tantan, is the dominant player in the digital dating space in China. The company estimates that the combined MAU base of Momo and Tantan is less than half the addressable market in China.

We believe Momo will continue to convert the 87% of free MAUs to paying MAUs. In addition, they are beginning to press more buttons to entice MAUs to spend more, particularly in the virtual gifts arena (if you think luxury watches yield an attractive margin, try a virtual gift!).

Online and mobile device dating is set for a long run of secular growth in my opinion. Young people today are much more comfortable meeting people digitally than those from past generations.

The market acceptance of Match Group's match.com and tinder apps has been robust both in terms of subscriber growth and stock performance. Since the company came public in November of 2015 at a price of ~.50, the stock is up around 460% showing positive perception of the business model.

I believe Momo has lots of hidden pricing power. Tantan is projected to be a growth beast in the next few years similar to the way Tinder has been for Match Group. Tantan is the leading mobile dating app in China and has 4.5m paying users. It just began monetizing its traffic in 2018 and is vastly under-monetized at this point.

A look at Match Group's strategy shows Tinder as the dominant growth mechanism for that company. Tinder has been a massive market cap contributor for Match Group and, over the last couple of years, has contributed 100% of the YoY growth in subscribers.

Tantan is competing in India and Southeast Asia markets for share as well. Markets outside of China are very competitive, so I see these markets as a remote possibility to bring in substantial revenue. Momo's management states that it is constantly weighing the situation and will not endlessly pursue other markets if it's not working out.

Let's compare paying user growth between Momo and Match Group. Match's paying user's totals around 9m with a growth rate of around 16%. This pales in comparison to Momo's 13.4m paying users. Match Group's market cap is more than 3X that of MOMO.

Competitive Advantage

Being the dominant, market-leading player in China creates a strong moat to ward off competitors. The more men and women there are available on a dating site, the more attractive the site is from a potential membership standpoint. Romance seekers understandably desire a large selection of candidates.

Size is now creating barriers that future competitors cannot hurdle. Wang Yu, CEO and Founder of Tantan talks about the barriers to entry, market domination, monetization, and how well the acquisition from MOMO went in this insightful podcast (minute 38 forward).

The Chinese market is somewhat protected from outside companies competing for market share there. While we in the U.S. may bemoan unfair trade practices, the Chinese firewall works in Momo's favor.

Another advantage in the space is that Momo has a much larger percentage of female member/users than do the other dating sites in China purportedly at around 40% of users. This is important because there is a significant male/female imbalance in China owing to the past one child policy. 15% of men in China in years 2020 to 2050 may find themselves without a partner. This is a problem that Momo's business model attempts to help people solve. Facilitating love and the matchmaking process should be a good business for a long time in China.

Why Undervalued?

Going back a bit in time, the Chinese government on April 29th, 2019 suspended new Tantan downloads at the Apps store level, which understandably caused lots of distress in the stock price. The share price dropped around 30% over the next 10 days but subsequently recovered after an excellent 1st quarter report and reinstatement of the app on smartphone platforms. Nevertheless, the stock is still down around 44% from highs of mid-June 2018.

The downdraft in China's economy over the past two years and the U.S./China trade disputes in 2019 are two more contributing factors that have impacted shares of Chinese stocks in general. Currently, while trade disputes may hurt the Chinese economy overall, Momo's revenues are based on Chinese consumers and are not reliant on exports nor subject to any trade restrictions.

Share prices enjoyed a nice lift over the past 2 months, briefly cresting before the coronavirus hit China. Since then, shares have declined to as of today, and the shorts are piling on, an overreaction to the virus, which has claimed 56 deaths and infected 2,000 as of this writing. The share price could fall further, and if it does, we will buy more. I believe China will overcome the virus as the government is resolute about containing it.

Momo's performance in Q3 was right on track. The numbers were solid with 22% revenue growth and 50% diluted EPS growth per ADS. It's difficult to attach an earnings growth rate to the company owing to the acquisition of Tantan, lots of investment, and elevated stock based compensation. My best guess is that it will average around 20% annually for the next 5 years. Q3 EPS X 4 puts the shares at 13.1X today's price tag after the 30% drop of the last few days. Bears are opening up short positions. But when you think about it, people meeting online seems safer than meeting in person for sure. My heart goes out to the Chinese people that are exposed to the coronavirus outbreak, but I'm not worried long term about Momo. Momo has around B in current asset war chest and an under-monetized cash generating machine of the future (Tantan).

Valuation

At a Friday ADS price of , Momo trades for 2.7X Q3's sales annualized, and 13.1X earnings. The market cap is .2B. Price/Sales is an important metric for comparison of fast-growing companies that may be investing heavily in growth, thus suppressing earnings. Momo revenue growth in Q3 was 22%.

U.S. based Match has been a fantastic stock to own. For valuation comparison, it trades at 12X sales, 48X earnings and is growing revenue at 15% per annum over the past 5 years. Match Group's stock has rallied 150% over the past 2 years while Momo is down 5%. Are dating prospects that much better in the sans-China world over the past year? China has 200 million singles.

The following chart speaks for itself. The revenue growth opportunity in the China dating space looks exceptional!

http://www.iresearchchina.com/Upload/image/20190315/20190315151019_5146.png

Potential Negatives

  • The coronavirus proves unstoppable. Unlikely but possible.
  • China allows Match to compete in China. Unlikely but possible, and Momo would still have a fighting chance.
  • Momo starts rapidly losing market share to a new hot Chinese dating app. The investment to pull this off would be large and the task, difficult.
  • Return on capital deployed in the future is a concern, though we believe Tantan was a good acquisition and will pay off in the future.
  • Regulatory interference is a threat.

Management/Ownership/Corporate Governance

Yan Tang, Chairman, Co-Founder and CEO owns just over 20% of the outstanding shares. I prefer to own companies run by a founder/entrepreneur when possible as they often have the best interest of the company at heart while thinking long term. Mr. Tang has over 70% voting control of the company through ownership of class B shares, which is a concern. This dominance may prevent the board from acting independently.

The company has paid a couple of special dividends in the recent past with a special dividend in April of 2019 of 0.62 per ADS, equal to approximately 25% of adjusted net income. It's nice to see occasional return of capital to shareholders.

Tantan founder and CEO Wang Yu is very capable in my opinion and stayed on as CEO of Tantan.

Conclusion

Take advantage of the previous regulatory trouble, China's weaker economy, the trade disputes, and the new coronavirus threat which have held Momo's share price in check over the past couple of years. Good things happen when you purchase a company with 1) low capital investment requirements, 2) a great balance sheet with minimal debt, 3) fast revenue and earnings growth, 4) a cheap current valuation owing to a crisis 5) excellent, aligned management.

Disclosure: I am/we are long MOMO. 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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