I have been writing about Momo (MOMO) since July 2017, when I introduced it as the third stock in the Potential Multibaggers series. I have written six previous articles and in all of them, I was very positive about this Chinese mobile platform. I am amazed that the stock is still so cheap. On Tuesday, March 12, 2019, Momo released its Q4 and FY 2018 earnings. Again the results were excellent: as every single quarter since its IPO in 2015, Momo beat on earnings and revenue and the stock popped: +12%. But even after this rise, the stock is incredibly cheap.
Momo, a short introduction
For those who wouldn't know Momo, a quick introduction.
Momo is a mobile platform in Chinese. The original app was a social networking platform based on location and interests. Basically, this means that you can meet people who are near you and/or have the same interests as you. That gave it its name of a hook-up app, although the company didn't like that at first. But Momo has much more: chatrooms, karaoke, social groups, social mobile games, etc.
The first big shift for Momo come with Hani, its stand-alone video application. A year ago Momo had its second big shift: it bought TanTan, which you could call the Chinese Tinder. I thought this was an excellent acquisition since Momo had become the most important dating app and TanTan was number two.
(logo of Tantan, Google Play store)
Momo: always beating
On Tuesday, March 12, Momo jumped 12% after it had released its Q4 and FY 2018 earnings before the market opened. Those earnings were excellent, as I am have grown to expect from this company. After all, Momo has beaten expectations every single time since its IPO in 2015:
All the green arrows you see are all positive earnings surprises. As you can see, all of the earnings releases that Momo has announced so far as a public company, were better than the analysts had expected: a perfect 14 out of 14. I wish every company in my portfolio had the same track record.
The Q4 and FY 2018 earnings
In Q4 2018, Momo's revenue rose by 50% to 3.84B yuan (about $573M). What can you say about 50% revenue growth, besides the fact that this is an outstanding performance? I think this shows the power and the resistance Momo has. For years, some specialists have been saying that Momo's revenue growth will fall off a cliff.
The reasons they give are diverse, but keep coming back. A highly competitive market for social media platforms is one, but Momo's core app users keep growing. Another one is 'peak live broadcasting', but the numbers were up impressively: 36% YoY revenue growth from live broadcasting. TicToc shift! But Momo's average time per users was up a lot. Throw in 'peak virtual gifts' (Momo's VAS without TanTAn grew by 157%) etc. Momo shows that all of these claims don't stop it from huge revenue growth.
As for the profit numbers: these were impressive too. The Q4 adjusted operating income was RMB1.03 billion ($153.5), up 30% YoY. For the full fiscal year 2018, total revenue came in RMB13.4 billion (almost $2B) and up 51% YoY. The adjusted operating income for FY 2018 reached RMB3.9 billion ($581M), up 42% YoY.
So unlike a lot of other high-growth stocks, Momo is hugely profitable. And without Tantan's financial impact, the profitability would even have been higher: RMB4.2 billion ($632M).
Momo invested heavily in 2018: the cost of revenue was RMB2.08 billion($310M), up from RMB1.32 billion ($197M) for the same period last year. With an extra 57% spending, a lot of companies would see their bottom line wither. But not Momo. Tang Yan, Momo's founder-CEO, was righteously very proud of the bottom line margins, which grew despite the very heavy investments.
During the year 2018, we have made significant investment in strengthening the content ecosystem and expanding the talent pool to better support our research and development efforts. These investments have laid a solid foundation for us to drive further product innovation as well as revenue growth in the year 2019. Even with these significant investments that we've made, I'm pleased to see that on a ex-Tantan basis, we were still able to deliver an improvement in bottom line margins as compared to the prior year.
Because of that huge profitability, Momo is able to give a present to its shareholders: a special dividend. When I read the announcement, I had to chuckle. Just a few months after Match Group (MTCH) announced its $2 special dividend, its Chinese equivalent does the same.
The special cash dividend is $0.62 per ADS, a 1.64% one-time yield at the current price ($37.76 at the moment of writing). The total amount of cash dividends the company will have to pay will be around $128M. On the Q4 2018 earnings call, Momo's CFO Jonathan Zhang said:
As of December 31, 2018, Momo's cash, cash equivalents and short-term deposits totaled RMB11.3 billion compared to RMB6.9 billion as of December 31, 2017.
RMB11.3B is 1.656B American dollars, which is huge for a $7.5B market cap company. The special dividend will only take 7.72% of the total cash reserves, which is peanuts.
I know that a lot of growth stock investors don't like special dividends, but for Momo I think this is actually a good thing. Tantan has been acquired a year ago and I have the feeling that Momo is still integrating the acquisition in its ecosystem, so the extra cash just lies around and the company still has enough money on the bank after the special dividend has been paid out to buy an unexpected opportunity. For those who want to get in on the stock after the earnings, there is still time to buy before the ex-dividend date, which is at the close of the market on April 5, 2019. The dividend will be paid on April 30.
Yan Tang explained about the dividend on the earnings call and said that more special dividends could follow, but also stressed that Momo will continue to have a disciplined acquisition approach:
If there are opportunities that can strengthen our position in a way that Tantan has, we will strive to capture them. And if we continue to generate excess cash flow compared to our meaningful operation and investment and if deemed by our Board of Directors to be in the best interest of our company, we may continue to share our prosperity with the shareholders in the form of future dividends.
For any platform, the number of users is extremely important and here too Momo keeps delivering at a high level. The core Momo app had 113.3 million monthly active users (MAUs) in Q4 2018, a growth of 14% YoY and up 2.8 million users (2.54%) QoQ.
But not only the number of users grew. The time the average user spent on Momo's platform reached an all-time high. The reason is quoted by Tang Yan:
During the past two years, we have made tremendous progresses in enriching the social features to broaden the form of interactions as well as diversifying the ways of connecting people. Three years ago, when people came to Momo, what they could do was pretty much limited to checking out Nearby People and IM-based chatting. Nowadays people are connecting and interacting over a variety of different use cases including nearby functions, live shows, short video, social games, karaoke and other form of audio and video experiences.
And Momo has a strategy to grow its users over the next two quarters:
During the coming two quarters, one of our key strategies is to leverage new use cases and go after the huge amount of dormant users, pull them back through effective channels and see if we can better retain them.
(Yan Tang on the Q4 and FY2018 earnings call)
The user growth on its own is of course important, but what I like about Momo's management is that they also think of the profitability too. The fact that audio and video have become much more important, makes monetization easier. And that can be seen in the huge growth of the revenue of the Value Added Services (VAS): 272% YoY to $105.1M, already contributing 18.32% to Momo's total revenue.
Of course this includes the subscription business of TanTan, but what do you think is the main contributor? Virtal gifs, the profit machine that has made Tencent (OTCPK:TCEHY) so big. Virtual gifts revenue was up 157% YoY for Momo. This bodes very well for Momo, since this is a very high margin business: it costs virtually nothing to make the virtual gifts. And according to Yan Tang, the growth here is not over yet:
We are seeing a great deal of potential here and we'll continue to pursue these opportunities in 2019.
An example of a new strategy that has potential was given by Wang Li, Momo's COO and President:
In January, we rolled out an interactive gift card Penguin Hitting. When a user sends a traditional gift, it is simply a virtual gift with certain special screen effect. An interactive gift such as the Penguin Hitting comes with a game that allows the users to have fun and compete with other users in the same live channel. That way, the users can enjoy themselves even with a limited amount of spending.
And that is just one example. Momo will continue to innovate and monetize these high-margin virtual gifts. Only 30% of DAUs (daily average users) spend time on the live streaming channels, although this is by far the biggest contributor to the revenue. That means that 70% of DAUs can still be monetized, a huge opportunity for Momo. About that 70% unmonitized DAUs, Wang Li said:
We believe these users also have strong inclination to pay for value added services, as long as we give them a good reason to do so. In 2019, we'd like to see ourselves move a bit faster in experimenting on paying use cases for virtual gifting across the different non-talent show experiences that we offer on the platform.
I really tend to agree with him. Wang Li added that the VAS revenue is very resistent to the macro economic trend because the average revenue per user (ARPU) is low, meaning people will not cut on these tiny expenses. This is actually a good point, which I hadn't thought of before. The fact that Momo has done so well while the Chinese growth is slowing down a bit, is a first sign that Wang Li is right.
The mobile marketing business showed the importance of the slowdown resistance in VAS. Mobile marketing revenue was down 15% YoY to RMB122.1M. Wang Li:
The decline was caused by the challenging macro environment, as well as the regulatory changes in some of our big ad sectors. Our current expectation is that the macro environment will continue to be tough for mobile marketing business in the year 2019. Therefore, instead of aggressively pursuing growth opportunities here, our strategy is to increase the operating efficiency of the mobile marketing team. We plan to apply the same strategy to the downsized game business in the year 2019.
Tantan could be called the Chinese Tinder, with the same swiping left or right. It is in fact so similar that Match Group (MTCH) sued TanTan for a patent infringement for its "swipe to like" concept and for connecting people who both swiped right. TanTan had to redesign its US app (and only that one, not the core Chinese app) and pay royalties based on its monthly active users to Match. But TanTan has more than just swiping also has a sort of quiz game to help to get to know each other better in a pleasant and non-committing way, which actually resembles Momo's strategy with its social apps: gamifying and setting up contests to strengthen user interaction.
Match Group usually talks about subscribers for Tinder, not the total number of users. The last number available was 50 million users, of which 10 million are daily users, but I think this has gone up considerably considerably since August 2018. in Q4 2018, Tinder had 4.35 million paying users (subscribers).
In its last earnings slides deck, Match shared the number of singles who had used a dating app:
As you can see, the number of users of dating apps has gone up fast over the last few years in the US, especially in the younger age group.
Tantan, in the meantime, has still less users than Tinder, although it has copied Match by only talking about the subscribers now on earnings calls. TanTan started the monetization of its app only in Q1 2018: in January it started its VIP service. Then later, in July, it added two extra paying services: A See Who Likes Me stream and Super Exposure. I think the names indicate well enough how they work.
With these three services, TanTan already has 3.9 million paying subscribers. To put that into perspective: 3.9 million is already 90% of Tinder's number of subscribers. That is of course because the Chinese population is gigantic but something else could be at work too. There is a lot more competition on the Chinese dating market for men compared to the western world because of the one-child policy of China. The result is that there are 70 million more men than women in China. That could lead to a higher number of users as a percentage of singles over time. Wang Yu, founder and CEO of TanTan on the earnings call:
We believe that our potential for dating in China is as high, if not higher than the West. But we probably need to use some, besides subscription based models, use some non-subscription based models to fully unleash our potential.
This means that there is a lot of growth potential for Tantan, especially if you know that Momo was considered to be the second biggest dating app of China (bigger in total number of users, but not all for dating). Now that the number one and two companies are combined, they can join their efforts to make dating apps more socially acceptable and, more important for us as investors, more profitable. The ARPU of TanTan will be lower than for Tinder at this moment, but with the rise of the Chinese middle class, the ARPU is expected to grow for years and years.
In Q4, TanTan's total revenue was RMB223 M ($33M) up 36% QoQ. While this is only a small number, I think the Chinese dating market could still be in its infancy and I expect it to grow for at least a decade. The first year of monetization is always trying out and seeing what works. The fact that it already works so well is a positive sign. The results exceeded the expectations of the management, which always is a good sign.
And that outperformance of TanTan is set to continue. Again Wang Yu on the earnings call:
With that said, so far into Q1, we have been outperforming our own expectations on user growth by quite a lot. As an indication, we expect that the quarterly add-on in paying users to increase very significantly from 300,000 net add that we saw in Q4 and even surpass that of the net add of Q3. We are testing a number of different new premium features, some of them are subscription based and others are not. When we feel that we're ready, we'll do an official launch. But we will take our time in testing the features to make sure we do the things right.
Just as a reference: the Q3 number of new subscribers (so paying customers) was 500,000. The fact that management expects that number to be surpassed in Q1 2019 because of the new initiatives, is very bullish for TanTan's future. I really like what I see here.
Guidance and future
Momo expects its revenue to grow by 28% to 32% YoY in Q1 2019, ranging between RMB3.55 billion and RMB3.65 billion. The management expects further weakness in advertising and further growth in VAS.
What I also liked from the conference call, was the answer that Tang Yan gave to a very good question of Tianxiao Hou of TH Capital. Tianxiao Hou asked if Momo thought of bringing new apps to the market targeting other demographic and social groups, just as Match has done.
Tang Yan said that to keep penetrating deeper into the market, you need more solutions. Momo is already in the process of developing products to target other demographic groups. He asked for some patience, though, since the process needs some trial and error time. He also mentioned the possibility of M&A for additional products.
Expected revenue growth of 30% midpoint for Q1 2019: this must be one of those high-flying birds, who keep performing until they come down because the lofty goals are not met, right? Wrong. It is incredible how low Momo is valued.
Even after the uptick of the stock price after earnings, the company trades at a ttm P/E of just 17.8. Its forward P/E is just 13 and that for a company which is expected to grow its revenue by 30% next year and almost 20% in the years that follow. If those numbers are not beaten again.
Normally I don't use FastGraphs for growth stocks since the tool is more suitable to find undervalued value stocks and a lot of excellent growth stocks are not particularly undervalued. But Momo is the exception:
Even with a very conservative P/E of 17.2, a bit under the ttm P/E, you can see returns of 22% annually over the next few years. And that is excluding the fact that Momo is a very prudent forecaster, giving attainable guidances and then beating them each time. The potential return also excludes the special dividends the company hinted at could be given again in the future.
If Momo would have a PEG of just 1 (so the P/E is the same as the expected growth over the next few years), your return could be almost 40% annually for the next few years. This stock is dirt cheap! Do you know any other stock that has grown revenue by 50% this year, is expected to grow revenue by 30% next years and around 20% for the years to follow and trades at a forward P/E of just 13? If so, please let me know in the comment section.
Think for yourself
Why is Momo so undervalued? Well, it is a combination of several elements, as usual in life. There are the challenges of competition, there is the China discount, but it is also the very bad analyst recommendations.
This is what Morgan Stanley did in December 2018, just three months ago:
Just like that: a target price from $61 to $30. That must be a disastrous company and huge problems must be brewing under the surface, right?
Nope, Momo released excellent earnings again and so, without any apparent shame, this is what the Morgan Stanley analyst does:
This is such a ridiculous coverage and shows that as an investor that wants to outperform, you really have to think for the long term and ignore analysts and their short-term mumbo jumbo price targets altogether.
What I see when I look at Momo is that it is building out a diversified platform, with chatrooms, live video streaming, dating, gaming and much more. The company's management clearly understands the Chinese market and its consumers very well. On top of that, there is a huge potential to monetize TanTan, the Chinese Tinder and other dating apps could be added to the ecosystem. The fact that the stock is still so undervalued (forward P/E of 13, expected revenue growth of 30%) is, in my opinion, an opportunity for every long-term investor.
If you liked this article and you want to follow my updates on Momo or other attractive growth stocks, please hit the follow button next to my name.
In the meantime: Keep growing!
Disclosure: I am/we are long MOMO, MTCH. 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.