Cheetah Mobile Q2 2014: Rationalization Kicking In

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 |  About: Cheetah Mobile Inc. (CMCM)
by: WestEnd511

Summary

CMCM's 2Q14 beat consensus with optimistic guidance for Q3.

However, uncertainty over the monetization of the MAU base is beginning to reflect on the market sentiment.

Reiterate my bearish view on the stock.

Cheetah Mobile (NYSE:CMCM) reported 2Q14 results with both headline revenue and EPS beating consensus. The company also gave upbeat guidance of $69-70m in revenue, compared with consensus $65m. Shares rallied post result, +8% on solid headline numbers but pulled back over the day, finishing -1% to close the day. Evidently, the market is becoming more rational at CMCM's growth prospect and the reality that the near-term monetization of its mobile users highly unlikely. Most troubling, engagement level, which the author measures as mobile MAU as percentage of total install base, declined sequentially by 40bps to 42.9%. I view this as a reflection of the challenges that CMCM is facing on solidifying user loyalty and stickiness with an undifferentiated product amid a highly competitive mobile security market that requires both scale and broad product portfolio. Despite the headline numbers, I remain bearish on the stock.

In-line near-term growth, but competitive pressure remains

CMCM's headline numbers were solid across the board and this is within my expectation that the near-term revenue growth will likely to be strong, driven by MAU growth. Online advertising revenue of RMB283m (+112% y/y) saw a sequential acceleration from Q1 (+97% y/y) while IVAS revenue growth decelerated sharply (+571% y/y vs. 15x growth in Q1) due to competitive pressure from Tencent in the mobile game space. Management acknowledged that Tencent has ramped up heavily on its mobile game ecosystem during the quarter, which has pressured the other domestic mobile game developers' profit. I expect the competitive pressure to remain in the near-term in that CMCM lacks scale, network effect and financial resources to compete effectively against company such as Tencent. In addition, I also expect that overseas mobile game business will take longer than expected to ramp up (another fact the management has acknowledged).

MAU monetization continues to be a long-term dream

Looking beyond the headline MAU number of 284m (+255% y/y) indicates that the management has been masking weak engagement metrics with aggressive expansion of the install base (662m). I note that the engagement level declined 40bps q/q. One reason could be the aggressive promotion of the Clean Master among the mobile handset makers in China, India and Europe, which I consider a low quality growth in that the company essentially pushes the application onto the handsets to inflate the total instalment statistic.

Given the competitive nature of the mobile security market, users are more willing to use the brand they are more comfortable with. In China, the majority of the users will prefer Qihoo (NYSE:QIHU), Tencent and Baidu (NASDAQ:BIDU), while users in the developed market would prefer Lookout. As such, the total instalment figure is meaningless at best, especially when the users (including this author) can easily delete the preinstalled Clean Master app from the new device and replace it with an app of my choice (Lookout).

The most troubling commentary from the management during the call is regarding the monetization of Clean Master. Management is optimistic on the CM's MAU growth but also reminded investors that CM's core strength is not only its eventual monetization but also its ability to cross-sell other CMCM's mobile products, which I also believe to be equally difficult to monetize given the lack of product sophistication. In short, I believe the management was trying to divert the market's attention given that much has been focused on CM's eventual monetization.

In conclusion, the market's expectation on CMCM is evident in its intra-day performance post Q2 as rationalization kicks in. Expectations will be in check given that the market was clearly overly optimistic heading into the earnings. With much uncertainty surrounding the monetization of the MAU base and the overseas mobile game business, investors are better off staying on the sidelines for now. Reiterate my bearish view on the stock.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.