IPO Preview: YY Inc.

| About: YY Inc. (YY)

Based in Guangzhou China, YY Inc. (NASDAQ:YY) scheduled a $90 million IPO with a market capitalization of $612 million for Wednesday, November 21, 2012.

F-1A filed November 7, 2012.

Manager, Joint Managers: Morgan Stanley; Deutsche; Citigroup.
Co Managers: Pacific Crest Securities; Piper Jaffray.

YY is a fast growing social and gaming company in China. For the nine months ended September 2012 sales were up 167% to $88 million from $33 million. YY became profitable, reporting a profit of $9 million up from a loss of $14 million.


  • YY only became profitable this year, and is significantly dependent on sales of tokens, etc for games.
  • The public entity is based in the Cayman Islands. The public entity then owns a shell company in the British Virgin Islands, that then also owns another Cayman Islands company, that then owns companies based in Hong Kong, Bejing and other cities, etc. See the org structure here.

    The organizational structure is enough to pass on the IPO.

  • Also, YY has set up a dual stock class the insiders control 98.3% of the votes post-IPO. IPOdesktop doesn't like to see insiders have 98.3% voting control.
  • In this economic climate, a P/E of 51 seems high for a social gaming company in China that only became profitable this year.
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Pass on the YY IPO. Although if you want to speculate on a China social/gaming deal, this is as good as they get. The organizational structure is typical for a China-based IPO.

There have been reports that in the past company owners of China mainland operation companies went ahead and sold their off-shore (Cayman, British Virgin Islands, etc) shell (NYSEARCA:IPO) holdings and retained ownership of their operating companies in China.

And there is/was no legal recourse.

Each ADS represents 20 Class A common shares

Dual stock structure
- Holders of Class A common shares (from the IPO0 will be entitled to one vote per share
- Holders of Class B common shares will be entitled to ten votes per share.
- Post IPO Class B common shares will represent 85.3% of outstanding stock, and will have 98.3% voting control.

IVAS: Internet Value Added Services

YY believes it is a revolutionary rich communication social platform that engages users in real-time online group activities through voice, text and video.

YY Client, the core product launched in China in July 2008, has attracted 400.5 million registered user accounts as of September 30, 2012.

YY achieved 10.0 million peak concurrent users and approximately 70.5 million monthly active users on YY in August 2012. However, because YY does not operate its platform on a real name basis, certain metrics may overstate the number of unique individuals using or paying for YY's products and services.

Free Basic Use

While the basic use of YY's platform is currently free, YY monetizes its user base through internet value-added services, or IVAS, and online advertising.

Currently, revenues from IVAS are primarily generated through sales of virtual items and game tokens that users may purchase for use in online activities on YY's platform, including online games, which are all web games, and YY Music, YY's music channels on YY Client.

YY derived 42.3%, 68.3%, 72.7% and 84.8% of total net revenues from Internet Value Added Services in 2009, 2010, 2011 and the nine months ended September 30, 2012, respectively, with online advertising accounting for the remainder of our revenues.

YY generates a significant portion of revenues from a limited number of popular online games on YY, all of which are web games, primarily through selling of game tokens to users for their purchase of in-game virtual items.

Revenues from online games accounted for 39.7%, 67.3%, 51.9% and 42.3% of total revenues in 2009, 2010, 2011 and the nine months ended September 30, 2012, respectively.

New online games are sourced primarily through revenue-sharing arrangements with third party game developers. YY must maintain good relationships with third party game developers to have access to new popular games with reasonable revenue-sharing terms.

Revenue shift
As the majority of YY revenues shift to Internet Value Added Services (IVAS) from online advertising due to an increase in the number of web game virtual items a user may purchase, the launch and increasing popularity of YY Music and YY's membership subscription program, and an increase in average prices of in-channel virtual items, YY has and will become more dependent on revenues from IVAS.

There is significant international pressure on the Chinese government to adopt a flexible currency policy to allow the Renminbi to appreciate against the U.S. dollar.

Significant revaluation of the Renminbi could have a material adverse effect on YY's ADRs. Substantially all of YY's revenues and costs are denominated in Renminbi.

YY faces competition in several major aspects of its business, particularly from companies that provide online social networking, internet communication and online games. YY also competes for online advertising revenues with other internet companies that sell online advertising services in China.

Social connectivity and communications
YY is not aware of any other company that offers a live voice- or video-enabled online social platform of similar scale as YY's in China.

In relation to voice-enabled communication tools, there are several internet voice communication service providers in China, including iSpeak, Tencent's (OTCPK:TCEHY) QQtalk and Dudu, and leading international internet voice communication service providers, such as Skype, that are expanding in the China market.

Online game media and hosting
YY has various competitors in the online game media market in China. Duowan.com's primary competitor among game media websites is 17173.com. For web game hosting, competitors include other major internet companies that host web games, such as Tencent, Qihoo 360 (NYSE:QIHU) and other private companies.

Several of YY's existing shareholders and their affiliates, including Granite Global Ventures, Steamboat Ventures Asia and Morningside China TMT Fund, have indicated to YY their interest in purchasing up to an aggregate of US$30.0 million of ADSs offered in this offering at the initial public offering price and on the same terms as the other ADSs being offered in this offering.

YY expects to net $79 million from its IPO. Proceeds are allocated as follows:

US$15.0 million to invest in voice and video technology and infrastructure, including purchasing servers and leasing more bandwidth to support an expanding user base and further enhancing user experience;

US$15.0 million to expand product development and services offerings, including through the hiring of additional research and development personnel and the further development of Mobile YY;

US$15.0 million to expand sales and marketing activities, including the hiring of additional sales and marketing personnel;

Balance for other general corporate purposes, including working capital needs, potential acquisitions, partnerships, alliances and licensing opportunities.

Disclosure: I 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. I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This YY IPO report is based on a reading and analysis of YY's S-1 filing, which can be found here, and a separate, independent analysis by IPOdesktop.com. There are no unattributed direct quotes in this article.

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