Tencent's Partner Mogu Is Quite Expensive At 11x Sales

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About: MOGU Inc. (MOGU-OLD), Includes: TCEHY
by: Wilsonville Capital
Summary

Mogu Inc. offers fashion and lifestyle content for young females between the age of 15 and 30.

Other large corporations growing revenues and with fat gross profit margins trade at 5x-8x.

Mogu, without revenue growth and reporting losses, should not trade at more than 5x-8x.

The assessment of shareholders reveals that the company is expected to be controlled after the IPO.

The company is incorporated in the Cayman Islands, wherein shareholders in the United States are not that protected.

The fact that Tencent (OTCPK:TCEHY) is a shareholder of Mogu (MOGU-OLD) is very beneficial, but Mogu’s revenues are declining by 13% y/y and the company reports losses. With other Chinese companies listed in the United States trading at 5x-8x forward revenues with large revenue growth and fat gross profit margins, analysts would not be able to justify Mogu’s shares at 11x forward revenues. Further, Mogu is incorporated in the Cayman Islands, wherein shareholders in the United States are not that protected.

(Source: Prospectus)

Investors will appreciate that large banks are leading the IPO. Take a look at the image below for further details:

(Source: Prospectus)

Business - Tencent Is A Shareholder And Strategic Partner

Founded in 2011 and headquartered in Xihu district, Hangzhou, China, Mogu Inc. offers fashion and lifestyle content for young females between the age of 15 and 30. The secret sauce of the website seems to be a team of fashion influencers and very diverse content, which guides consumers to easily discover and purchase new products. The image below shows the way influencers retain the attention of clients with live streaming videos:

(Source: Mogu)

With live video broadcasts totaling approximately 3,000 hours on a daily basis, product reviews, fashion tips, celebrity on-screen and street runway, Mogu owns a large amount of content to offer. The results show that the company's strategy is working. For the twelve months ended September 30, 2018, it had 62.6 million mobile MAUs. Additionally, the users spend 35 minutes per day, on average, watching Mogu's live video broadcasts.

(Source: Mogu)

It is very relevant to note that Mogu is not alone. Investors should appreciate that the company signed a strategic partnership with Tencent, which is also a shareholder. Interestingly, Tencent seems to be helping Mogu in other ways too. Weixin Pay and QQ Wallet, other entities owned by Tencent, are also collaborating with Mogu. Read the lines below in this regard:

“Through our strategic partnership with Tencent, one of our principal shareholders and the owner of Weixin and QQ, we also have one of the few dedicated Weixin Pay and QQ Wallet entryways that help direct Tencent’s massive base of users to our platform when they look to fulfill their fashion- and lifestyle-related needs.”

- Source: Prospectus

Mogu, like other large websites, owns industry-leading AI and Big Data analytics capabilities that help improve operational efficiency and enrich the user experience.

43% Of The Total Amount Of Assets Is Goodwill

As of March 31, 2018, with an asset/liability ratio of 5.14x, the balance sheet looks stable. The amount of cash is also quite beneficial. In March 2018, the company reported $178 million, 34% of the total amount of assets.

43% of the total amount of assets is goodwill, which certain analysts should appreciate. If the company is able to execute a good post-merger integration and transform goodwill into revenues, shareholders should benefit in the near future.

(Source: Prospectus)

The liabilities should not worry investors. The company shows $101 million in total liabilities with $97.5 million in current liabilities. In addition, with no long-term debt and with Tencent helping Mogu, the financial risk seems very small on this name. The image below provides more details:

(Source: Prospectus)

Declining Revenues Along With Declining Losses

As compared to other IPOs by Chinese companies, Mogu seems a bit different. The company has not shown revenue increase in 2018. For the year ended March 31, 2018, sales declined to $141.7 million, showing a 13% decline, which growth investors will not appreciate.

It is beneficial that the losses from operations increased in 2018. For the year ended March 31, 2018, the company reported losses from operations equal to -$123 million, 20% less than that in 2017. In addition, net losses also declined at the net income level. For the year ended March 31, 2018, Mogu released losses of -$81 million. The image below provides further details on this matter:

(Source: Prospectus)

In the cash flow statement, Mogu shows a similar profile. CFO is negative, but losses decreased by 62% in 2018. For the year ended March 31, 2018, the company released -$45.8 million. The image below provides further details in this regard:

(Source: Prospectus)

Use Of Proceeds

Mogu will use the proceeds from the IPO to produce additional content, develop its technologies and sign more collaborations with brand partners. It is beneficial that the company will not use the proceeds to pay off debts or to pay previous shareholders. The lines below provide more details on this matter:

(Source: Prospectus)

Expected Equity Structure And Valuation

After the offering, there will be 2,369 million Class A ordinary shares and 303 million Class B ordinary shares. Let’s assume that the total amount of shares will be equal to 2,672 million shares. Each ADS represents 25 ordinary shares. With each ADS at $15, the expected market capitalization should be equal to $1.603 billion. The image below provides further details on this matter:

(Source: Prospectus)

Deducting $60.6 million that the company expects to receive from the IPO and $178 million in cash, the enterprise value equals $1.364 billion. Assuming forward revenues of $123 million, Mogu should trade at 11x forward sales.

In the prospectus, Mogu does not provide the name of any competitor, which is not ideal. The company only notes that it competes with e-commerce platforms and social media platforms in China. Read the following lines for further details:

(Source: Prospectus)

It seems extremely overvalued as compared to other Chinese companies trading in the United States. Take, for instance, Tencent Holding (OTCPK:TCEHY), which trades at 8.95x sales with revenue growth of 42% and gross profit margin of 47%. Baidu (BIDU) trades at 4.93x sales with revenue growth of 28%. Additionally, Iqiyi, Inc. (IQ), which offers internet video streaming services, trades at 5.28x sales. Mogu, with no revenue growth and losses from operations, should trade lower than TCEHY, BIDU, and IQ. It should not trade at 11x forward sales.

Business Structure

There is another very relevant issue that investors in the United States should understand clearly. Mogu’s assets are located in China. However, the company is incorporated in the Cayman Islands. The business structure is shown below:

(Source: Prospectus)

Most Chinese companies trading in the United States are incorporated in the Cayman Islands. Nevertheless, it is relevant to mention the risks for shareholders. Firstly, judges in the U.S. will not be able to take actions against the Mogu, since the company was not incorporated in the U.S. Additionally, securities law in the Cayman Islands does not protect shareholders like that in the United States.

Mogu Is A Controlled Company

The assessment of shareholders reveals that Mogu is expected to be controlled after the IPO. Directors control 81% stake in the company, which is not ideal. The Board of Directors could take decisions to benefit the largest shareholders, which may damage the interests of small stakeholders. The protection of shareholders is not that high. Read the following lines for further details in this regard:

“For so long as we remain a controlled company under that definition, we are permitted to elect to rely, and may rely, on certain exemptions from corporate governance rules. As a result, you may not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.”

- Source: Prospectus

The float will be quite reduced after the IPO. It means that there is volatility risk on this name. Investors should keep this in mind. The share price could move very rapidly, and money can vanish in a short period of time. Tencent owns 4%, as shown in the image below:

(Source: Prospectus)

Conclusion

With declining revenues and negative losses at the net income level, Mogu does not represent an opportunity for investors. It seems also expensive at 11x forward sales. Other large corporations growing revenues and with fat gross profit margins trade at 5x-8x. With this in mind, Mogu, without revenue growth and reporting losses, should not trade at more than 5x-8x. Finally, the company is incorporated in the Cayman Islands, wherein shareholders in the United States are not that protected.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.