It's rare to find a company as cheap as YY Inc. (YY) nowadays, but when you do find one, you need to buy with both hands. YY, which generated lots of FCF, is pretty much free once you net out its huge cash pile and stakes in other companies.
What is YY
YY is a Chinese live streaming company. Unlike US-based streaming companies like Twitch, YY allows consumers to purchase virtual items to gift to streamers, which the streamers can then exchange for cash. YY, as the middleman, takes a cut of the profits. This business model is oddly lucrative, with the company earning 401 million in live streaming revenues in the latest quarter, according to its 6-K. Live streaming revenues make up almost 95% of YY's revenues, with the rest being made up of games and other services.
YY also owns a portion of other live streaming services like games streaming service Huya Broadcasting (HUYA) and a foreign (to China) platform named BIGO. HUYA is publicly traded on the NYSE.
Getting YY's core business for free
According to YY's 6-K, YY has $1.92 billion in net cash as of September 2018:
We believe very little of the company's cash is used for business operations, as:
1. Much of its cash is in short-term deposits.
2. YY pays streamers after receiving the cash.
Of course, this includes HUYA's cash as well, which amounts to around 840 million, and netting that out gives ~1.1 billion of cash.
YY also has investments in several business, most notably HUYA and BIGO, both of which are streaming services but don't compete directly with YY. HUYA is focused on esports and gaming, while YY is focused on casual activities like chatting. BIGO, meanwhile, is focused on international streaming. HUYA is publicly traded, which allows for easy determination of its value.
According to HUYA's website, the company has a market cap of $3.8 billion.
(Source: HUYA website)
It is hard to estimate YY's stake in HUYA, but assuming Tencent (OTCPK:TCEHY) exercises its option in full to purchase 50.1% of voting power and buys up the class B common shares, which gets 10 votes instead of one, YY could have either ~51% or ~38% economic interest in HUYA, depending on how many class A shares YY owns. We believe these assumptions are rational given Tencent's desire to dominate the esports market and to gain control of HUYA at a low price.
Taking the midpoint, or ~45%, gives us a value for YY's stake in HUYA of about 1.73 billion.
To value BIGO, we will use HUYA as a comparable. Since HUYA and BIGO are both live streaming companies, we believe valuing BIGO this way is warranted. HUYA trades at ~5.2x Q3 annualized revenues. SA contributor Alex Haak estimates in his article that BIGO will generate 1 billion of revenues in 2018. Using a more conservative 4x multiple, despite the fact BIGO is growing faster and estimated by Haak to be more profitable than HUYA currently, yields a value of $4 billion. Haak estimates that YY owns ~35% of BIGO, which would value YY's stake at around $1.4 billion.
Adding up these parts, YY's stakes in BIGO and HUYA, combined with its cash, yields ~4.2 billion in assets. The company's current market cap is ~4.1 billion. This means that an investor who buys YY stock is basically getting the company's core business for free.
The core YY business
While YY's steep drop might make people think that it is a cash burning, money-losing franchise, in fact, it is the opposite. The company is a cash cow generating significant profits year after year.
Some might think that the company's revenues are declining significantly, warranting its low multiple, but that would be wrong as well, as YY is growing YOY.
To grasp the extent of YY's value-generating abilities, all you have to do is to look at its cash position and shareholder equity graphs.
(Source: 20-F, YY Capital)
YY generated $510 million in FCF in 2017. Note that HUYA was slightly unprofitable at this time, so it shouldn't materially affect the figure. We believe a business generating that much FCF shouldn't be trading for free.
YY's revenues, excluding HUYA, aren't in decline either, as they grew from 2.51 billion RMB in Q3 2017 to 2.82 billion RMB in Q3 2018. If HUYA is included, revenue growth becomes 33% due to HUYA's higher growth.
Although some are fearful of apps like TikTok competing with YY for influencers and user attention, company management states that there is still significant growth in MAUs and paying users:
During the third quarter of 2018 we recorded outstanding operating results, highlighted by a 20.7% year-over-year growth in our mobile live streaming monthly active users (MAU) and a 26.3% year-over-year growth in our total live streaming paying users.
Since the content in TikTok is different from that in YY, we believe most contributors at YY will remain. Contributor Tao Value notes in a letter that he noticed that many YY hosts continued contributing to the platform while opening TikTok accounts.
Either way, YY is well poised for future growth and continues to be immensely profitable. Getting such a business for free would be a dream!
YY hasn't be stagnating either. In its Q3 conference call, management disclosed an agreement with Xiaomi (XI), one of the largest phone companies in the world:
Today, we're very pleased to announce that we have entered into a strategic cooperation agreement with Xiaomi in late October. Under this arrangement, YY has the exclusive right to operate certain entertainment live streaming services on Xiaomi's primarily live streaming platform Xiaomi Live. This agreement will enable us to integrate both our high quality live streaming and extensive experience in life streaming operations into Xiaomi's ecosystem.
Source: Q3 conference call
This agreement is quite beneficial to YY and could see a lot more Chinese Xiaomi users start using YY.
Company management also talks about a fan carnival that they organised:
In September 2018, we hosted the YY Fan Carnival in Guangzhou, bringing together over 300 top tier live streaming hosts to produce a super verity show, integrating music, dance, gaming and many other entertainment programs into a single event that lasted three days. Over 250,000 fans participated in this event in person. More than 11 million viewers turn into the online broadcast. At the peak show time, the concurrent online viewer count exceeded 1.6 million.
Source: Q3 conference call
All these developments are quite bullish for YY and help to solidify its position as a leading live streaming platform. These initiatives also help to show that management is not asleep at the wheel, like some bears think, but are actively working to increase the value of the business.
For a company like YY, there are definitely several risks:
- Complicated VIE structure - Chinese IPOs are notorious for their horribly complicated VIE structures, which could deter potential investors and increase risk of fraud.
- Fraud - Many Chinese companies have been found to be fraudulent, but since YY is a larger company, and since we have visited its website several times and found nothing suspicious, we believe this risk is immaterial.
- Management control - As shown in the diagram below, most shares are owned by CEO Xueling Li. We are fine with this risk, as Xueling Li is incentivised to create shareholder value due to his huge share ownership. He is also a talented entrepreneur, having founded BIGO and HUYA.
(Source: YY's 20-F filing)
- Live streaming - YY is not an innovator in the live streaming industry, but rather an incumbent. This could mean slowing growth going forward. We believe this is not a significant concern given the company's bargain basement valuation.
Overall, we believe these risks are not material to the investment thesis due to the huge margin of safety in YY's valuation. Given the unpredictable nature of these risks, however, we would size our position lower as compared to investments in US companies.
YY will be reporting Q4 earnings soon. Although we doubt there would be anything that could change our thesis, we believe investors should not size their position fully before earnings so as to take advantage of any potential drops in the share price to buy more shares.
So, why is YY trading at such a cheap price? Most likely, the US-China trade war is the root cause. Before the trade war, YY was trading in the 90s to 100s. Now it's trading in the 60s.
The company, however, isn't directly impacted by the trade war, considering all of its business is conducted in China. We believe investors are selling off YY because they are panic-selling all Chinese companies without considering the merits of each, as most Chinese companies have been hit hard over the past few months.
Either way, the drop in the stock represents an opportunity that should not be missed by investors. We recommend investors pick up some shares before the trade war ends and the shares rebound. If the trade war continues, YY's cheap valuation and high margin of safety should reduce downside drastically.
Overall, we believe YY is one of the best bargains available on the market today, given its low valuation and the fact that the core business, which generates over 500 million in cash per year, is pretty much free if you buy YY. Downside is quite low and upside is significant, so we rate YY a Strong Buy.
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.