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Summary

  • YY is continuing its high growth path, and the growth expectations should continue to improve going forward.
  • The technology/internet sector sell-off and a bad reaction to a good earnings report created a strong buying opportunity.
  • The share repurchase program adds to the long thesis.
  • Content regulation worries are overdone.

Recent developments in the stock market have created an opportunity to buy shares of YY (NASDAQ:YY) at a significant discount. I have argued in my previous articles that YY is a fast growing company that deserves a higher valuation given the growth the company is delivering and is expected to deliver in the future. The technology/internet sector selloff has caused a 45% correction in YY's share price, while the fundamentals have improved in the meantime. Add to that the $100 million share repurchase program and you get a better probability of success on the long side.

Q1 highlights

The company reported Q1 2014 earnings a month ago, and the initial market reaction was negative, sending shares down almost 20% in the next couple of days. YY was already down significantly since its early March highs, and the downtrend was helped by worries about content regulation in China, although YY is still not affected in any way. Q1 revenue and earnings were once again above analyst estimates and the company guided Q2 revenue ahead of expectations, which is in line with previous earnings reports. Net revenue and non-GAAP net income increased 111.6% and 153% respectively. The gains were driven by 228% revenue growth in online music and entertainment, which accounted for 57% of total revenue in Q1. The number of paying users for the segment increased 103.2% year-over-year.

The company expects Q2 revenue between $119.2 million and $120.8 million, which was above the $113.6 million consensus at the time. Analyst estimates have trended up since the report to reflect the newly issued guidance. Given the previous "beat and raise" trends, we should expect additional earnings and revenue upside through the rest of the year.

Technology/internet sector selloff creates a buying opportunity

YY topped in early March around $90, which was the time the Nasdaq topped as well. The selloff in the technology/internet sector has driven YY's share price down 45% in just two months, and the stock is now 30% off its March all-time high. Since the fundamentals have improved in the last two months, I am more confident with my $126 price target, which translates into almost 100% upside from the current price. I base my price target on the fact that YY is going to deliver strong revenue and earnings growth in the future, and I believe that the current valuation is very attractive for growth investors. This is especially true when you compare YY to most of its peers (see table below). An added perk to my long thesis is the $100 million share buyback program. The buyback amounts to about 1.5 million shares, which would effectively reduce the free float by almost 6%.

Source: Yahoo! Finance

Beijing crackdown on online porn should not have a strong impact on YY

Beijing launched an anti-pornography program called "Clean the Web 2014." Barron's highlighted YY as one of the companies that will be affected by this campaign. Social media and online entertainment platforms are more exposed to regulatory risks. YY's CEO David Xueling Li noted in the Q1 conference call that YY is "supportive of government's regulations and government's crackdown on inappropriate and pornography content on the internet. We believe the government's control and monitoring will bring a lot of the good side effects to the industry, especially which will actually make competition, make long-term development of the industry in very good direction. So we actually support government's monitoring and regulations." So, this might not by itself be a bad thing for YY, and the company might even benefit from the campaign. Pacific Crest and Morgan Stanley are on the same page as they state that content regulation worries are overdone.

Conclusion

The recent selloff has created a solid buying opportunity. YY should continue to benefit from strong growth of its business segments and the overall growth of internet use in China. I am reaffirming my $126 price target, which translates into almost 100% upside from the current price. YY is undervalued when compared to most of its peers and the situation should be rectified in the next couple of months.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in YY over 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.

Source: Why YY Is A Strong Buy