Here we compare two of the (more or less) pure plays in the hot Chinese live streaming sector, Momo (NASDAQ:MOMO) and YY (NASDAQ:YY). The fortunes of their share prices have skyrocketed in a hardly fathomable way the last five years.
While YY"s shares haven"t exactly done badly with a five-year return of over 600%, earlier this year MOMO was up a stunning 22,500% or so and that in a mere 3.5 years. However, lately the going hasn"t been so good and YY has basically taken back some lost terrain.
At the minimum, these graphs show that stocks in social media can make fortunes, but given Momo"s travails of late, things can also go south. We sort of warned about this in the article we wrote about this name at the end of August.
Social Platform Economics
But let"s concentrate first on the potential upside, which lies in the business model of platform economics in general, and social platform economics in particular:
- Social platforms (platforms in general) have powerful network effects.
- Social platforms have little content cost.
- Social platforms (platforms in general) have large economies of scope.
- Social platforms + machine learning creates powerful increasing returns.
Let"s discuss these briefly. A platform is more useful when others use it, setting off network effects and a scramble to appropriate the first-user advantage.
However, the streaming media platforms like Momo and YY have low barriers to entry, hence a multiple of these have emerged. A Chinese crackdown has served as a significant cull (as we described in our article about YY), and others are likely to have failed anyway unable to obtain a minimum viable scale. This isn"t surprising, given the significant upfront investments required.
Yet, multiple platforms still exist, like those of Momo and YY (but also Tencent (OTCPK:TCEHY) and others). So this is not a winner-take-all market, the network effects are not all consuming like other social platforms, most notably Facebook (FB).
Indeed, there is little in the way of content cost, but these streaming media platforms have other significant cost to contain, stemming from the fact that the network effects are not all consuming and no real dominant player has emerged. This sets the platforms in competition against one another, and this involves a lot of cost:
- Marketing and sales cost, the cost to entice new users to your platform, instead of competing platforms.
- Revenue sharing to incentivize top contributors to stay.
- R&D: The cost to improve the possibilities of the platform for users and open up different revenue streams for them so they"ll contribute to your platform rather than the competition.
- Development cost, the cost to help contributors to improve (in theory this is win-win, at least if successful).
These are just the most obvious costs, and we"re sure there are more.
The history of these platforms is a nice illustration of the economies of scope. Momo started as a dating site. YY started as an online gaming site. Both morphed into something else, as once you have a lot of eyeballs accumulated, a platform simply provides you the opportunity to add new functions, bells and whistles.
We see this in business platforms all the time, where the likes of Workday (WDAY), Tableau (DATA) and Ellie Mae (ELLI) are adding features all the time.
All this potentially gets to a whole new level when machine learning is added. What machine learning does is tailor content to individual users. These users will become more engaged that way and contribute even more.
By contributing even more, they produce more data for the machine learning, enabling even better tailoring, creating a virtuous cycle. But the same virtuous cycle works with advertising (or, as we have seen with Facebook where the lines between content and advertisement are blurred, with political propaganda).
So in theory these are very powerful business models, especially with the addition of machine learning. And indeed Momo has been improving the algorithms that drive what content get maximum exposure (from the Q2CC):
The higher the content quality is the greater level of user exposure that piece of content can get on the platform... Regarding the question about personalized recommendation logic and content tagging logic, I think our system is pretty much based on what is called collaborative filtering. This is a rather complicated and sophisticated mechanism. To put it simple, the system will assign different interest tax to users according to their respective interest graph and then what you are going to see - what you are more likely going to see on the platform is largely determined by the type of content that other users with similar interest tied to you gravitate toward, and that gravitation is further defined by user actions such as clicking through liking or other type of engagement.
We haven"t found a similar quote from YY, but we"re pretty sure it"s doing something similar. It wouldn"t be able to survive for long without it.
Diverging fortunes?
As SA contributor Justin Giles explained, Momo"s shares sold off despite a solid top and bottom line beat in Q3 because of softer Q4 guidance and this:
However, for the second consecutive quarter, live paying users remained stagnant at 4.1 million. If Momo cannot get more users to start spending money on its platforms, it will be tougher for the company to remain a growth story as investors start looking at it from more of a value side.
Curiously enough, we ventilated our skepticism about the staying power of paying customers in our YY article published earlier in the week. Justin also noted the following:
On the flip side, while live paying users remained unchanged at 4.1 million, average revenues from those users jumped. Total paying users from value-added services also increased from 4.5 to 4.8 million with the Company seeing an increase in the average revenues per paying user.
The company"s cash position continues to climb jumping more than $ 100M from the second quarter. As of September 30, 2017, Momo"s cash, cash equivalents and term deposits totaled $ 949.7 million, compared to $ 846.3 in the second quarter and $ 651.3M from a year ago.
The shares of Momo are off from their highs by a great deal whilst YY"s haven"t suffered from a similar bout of investor angst, at least not yet. Is the skepticism towards Momo justified (in relation to YY)?
Growth
While YY is still selling 30%+ more, Momo is actually catching up. Indeed, revenues have grown way faster the last five years.
And Momo is still growing four times(!) as fast this year.
Margins
At first sight, one would argue a resounding no.
While Momo"s (GAAP) margins are trending down, they are still substantially higher compared to those of YY.
Other finances
As you can see below, Momo has almost caught up with YY in terms of EBITDA on an absolute basis, but considering YY"s larger revenues (and market capitalization) it has already caught up with YY on a relative basis.
And here is another telling figure, Momo is generating way more cash, and the difference is widening rapidly.
Neither company has debt, and both companies are mildly diluting (YY embarked on a substantial $ 442.2M secondary offering earlier in the year).
Valuation
The following figures are GAAP figures and backwards looking:
But they show that YY, despite growing much slower, has closed its earnings valuation gap and even overtaken Momo, as it has with the other valuation metrics.
Conclusion
The selloff of Momo is not easy to explain in isolation, but compared to one of its rivals, YY, it becomes harder still. Momo is doing better on a raft of metrics like growth, cash generation, and margins, often substantially so.
Yet the valuation gap has continued to narrow, and the selloff in Momo has been such that YY has even overtaken Momo on a valuation basis. It really is difficult to argue that Momo"s shares are expensive.
While we have some reservations about the sector (it could be a bit of a fad, and part of the earnings stream seems to be fairly uncertain to us), if you don"t have these qualms like we do, then the choice is pretty clear.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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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