Qutoutiao: A Once In A Lifetime Buy

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About: Qutoutiao Inc. (QTT)
by: In Search of Growth
Summary

QuTouTiao is growing at an outstanding rate with a 426% YoY growth in net revenues and a 286% YoY rise in monthly active users.

However, losses are growing at an even faster rate.

The stock is currently trading at a major discount from its 52-week highs with analysts predicting a +95% rise from current levels.

QuTouTiao has a very bright future ahead of it in its goal to become a major news platform for users in lower-tier cities in China.

QuTouTiao's core AI-powered news app. Source: businessofapps.com

QuTouTiao, or "Fun Headlines" in Chinese, is a popular AI-powered news feed and short video aggregator in China with 93.8 million MAU. It focuses on making its content light-hearted and humorous. QuTouTiao is more of a platform for news as it doesn't generate its own content. It uses artificial intelligence-based algorithms to create personalised news and video feeds based on the users' interests and behaviours. This custom content comes from over 580 established media outlets and over 600,000 registered freelancers on QuTouTiao's platform. QuTouTiao pays for the rights and then places ads, which account for 93% of its revenue.

QuTouTiao is growing at a frantic pace with net revenues having grown 426% and average MAU having skyrocketed 286% YoY in Q4 of 2019:

Metric

2016

2017

2018

Revenue

$8,720

$76,510

$456,720

Gross Profit

$7,640

$65,160

$379,990

EBIT

($1,640)

($14,070)

($289,690)

QuTouTiao's Revenue and Earnings Growth 2016 - 2018 (in 000's). Source: MarketWatch

QuTouTiao's User Base Growth. Source: ir.qutoutiao.net

So we have skyrocketing revenue (+5137% from 2016-2018), monthly active users (+1545% from Q12017-2018), combined with even faster-growing losses (+17,564% from 2016-2018). While this may be alarming to many investors, personally, I'm not very worried considering these costs were solely to acquire new users. In Q4 2018, sales and marketing, research and development and general and administrative costs all together represented just 14.4% of revenue. The grand expenses were user engagement (49.1% of revenue) and user acquisition (54.2% of revenue).

In traditional Chinese culture, a red envelope is symbolic for giving money as a present. Source: thestar.com.my

Now to acquire a new user, QuTouTiao doesn't use any ordinary marketing. Instead, it has gamified its platform. It uses a gamified loyalty program to boost its popularity and engagement. Users can earn loyalty points through consuming content, engaging with the platform or referring the app to friends. Users earn 1.5 RMB for referring new users to the platform. According to Reuters, Caí Li, a janitor in Shanghai earned a few hundred yuan ($30-$40) over several months to supplement her income simply by engaging with the app. While this may not seem like a lot, considering 70% of its users are from rural and lower-tier cities, $1 has considerable purchasing power. But there’s another reason why QuTouTiao is so popular in lower tier-cities.

Jinri TouTiao: QuTouTiao's biggest competitor. Source: investsize.com

Jinri TouTiao, or just TouTiao, Chinese for "Today’s Headlines”, is QuTouTiao’s biggest competitor. Its parent is Bytedance, the maker of popular short video app TikTok. It serves over 240 million MAU with users spending an average of 76 minutes a day on the platform. This has caused Jinri Toutiao's share of the communications app market to grow from 3.9% to 10.1%. This was at the expense of Tencent, whose apps lost significant market share, falling from 54.3% to 47.7%:

Share of time users spend on mobile platforms in China. Source: nealschaffer.com

This has only worsened the rivalry between Tencent and Bytedance in the battle between BAT (Baidu, Alibaba and Tencent) against Bytedance. This caused Tencent and Alibaba to back QuTouTiao to try to acquire more users and gain market share from Jinri TouTiao. It did this by targeting the highest-populated areas of China; tier-3 cities and below:

QuTouTiao's market has more potential users as well as growth in internet users. Source: ir.qutoutiao.net

This leaves them with a much faster growing and infant mobile news market that it can make use of to get a competitive advantage over Jinri TouTiao. It has also stated that there are significant advantages for targeting lower-tier cities:

Benefits of targeting lower-tier city users in the eyes of QuTouTiao. Source: ir.qutoutiao.net

In May of 2018, QuTouTiao launched another app called Midu. Midu is a free-to-read literature app with over 40,000 pieces of literature. Within just 9 months of the release, it became the second most popular reading app in China with over 8.4 million DAU:

The rapid growth of Midu, QuTouTiao's mobile literature app. Source: ir.qutoutiao.net

Since it's a free-to-use app, it has been able to acquire users much more quickly. Similar to QuTouTiao, Midu has personalised book recommendations that allow it to be extremely consumer-centric. It's also monetised in the same way; through ads enhanced by AI (based on their interests and behaviours). In contrast to QuTouTiao, however, Midu doesn't have a loyalty reward system for its users that makes it user growth much more impressive as it came with minimal user acquisition costs.

Valuation

QuTouTiao's stock chart over a 1-year period (9 months since it IPOd in September of 2018). Source: Seeking Alpha

QuTouTiao has fallen 62% from its highs of March 15th. While the trade war did contribute slightly to this in the past week, the main reason for the rapid sell-off was due to the widening losses discussed earlier. However, having fallen so much after the Q4 report, QuTouTiao's valuation looks quite attractive considering its 426% YoY growth:

Market Cap

PE

Price /Sales

Price / Cashflow

Price / Book

EPS

1.6B

-2.77

1.88

-2.7

0.94

$-1.06

QuTouTiao's relatively low valuation (at $6.30 a share). Source: Seeking Alpha

While widening losses can be frightening, its impressive growth will continue nonetheless. And while most startups don't give away cash to acquire new users, the lower pricing they place on their products has the exact same effect. One day it will be profitable and with a user base much larger than it is now, making a $1.6B valuation look like a steal. If it hits its 52-week low of $4.15, then just getting back to its 52-week highs of $15.63 would represent a 277% increase. Hopefully, the stock falls from the 6% surge we saw this Thursday before the earnings report on the 20th of May. In this earnings report, it is expected to display an EPS of $-0.35 down from $-0.22 with revenue of $169 million, down from $198 million in the previous quarter. If it manages to beat its estimates we could expect significant upside from current levels.

QTT's EPS from the previous quarter and estimates for the next quarter. Source: Yahoo Finance

These are QuTouTiao's current price targets from analysts:

Institution/Group

Citigroup

Deutsche Bank

UBS Group

KeyCorp

Price Target

$14.00

$10.00

$14.00

$11.00

Difference From Current Levels ($6.30)

+122%

+59%

+122%

+75%

Analysts' price targets for QuTouTiao. Source: MarketBeat

As shown, the following analysts predict an average upside of +95%. This great value for a hyper-growth stock is something extremely rare, potentially making QuTouTiao's a once in a lifetime buy at this price.

Over a long term outlook, QuTouTiao also has plenty of more room to grow as it expands into lower-tier cities and popularising its literature app Midu. Estimates from Simply Wall Street could help give us somewhat of a picture as to what it could achieve:

Simply Wall Street's estimates of QTT's real value based on future FCF. Source: simplywall.st

Simply Wall Street's estimates represent a 785% increase from current levels. While this price is far off current levels, it may not be too far away. QuTouTiao also may be profitable sooner than most of us might expect. Simply Wall St's believes QuTouTiao could be profitable as soon as Q4 of 2020:

Simply Wall Street estimates of QuTouTiao's future EPS. Source: simplywall.st

Risks

QuTouTiao's core app on the App Store. Source: App Store

The most evident and significant risk facing QuTouTiao is its user engagement once it stops its loyalty program. One cannot help but ask, has QuTouTiao's average time spent per DAU on the platform increased from 31 minutes to 63 minutes due to the fact that their content is more engaging or because users get paid more by interacting with the platform more? We can take this a step further and ask: How many of QuTouTiao's users are on the platform solely for financial incentives? In their Q4 conference call, QuTouTiao's management actually addressed this issue:

"Before concluding our guidance, I want to talk a little bit about the nature of the loyalty program. The monetary value of the loyalty points given to users is just RMB 0.2 per DAU, which would be negligible as an incentive for anyone to use our products if they wouldn't be interested otherwise. The main reason our users have chosen us is the appeal of the content and the fun experience we offer. Our loyalty program is very much like the frequent fliers programs offered by airlines. Nobody takes the flight just for the miles, but the miles enhance customer loyalty."

While this is a risk, it has been treated as a much bigger issue than it really is. As it continues to grow, QuTouTiao will reach a certain threshold where it becomes popular enough that people view it as a well-trusted news source and word of mouth will do the work for them. This early stage is the most difficult phase of a startup and QuTouTiao has shown how easy it is to do, if you have money to give away of course.

The other clear risk that arises is competition. Jinri TouTiao is considerably larger than QuTouTiao and has managed to grow without needing to reward its users. It's currently in a much better position on the market and it seems as if QuTouTiao will lag behind for some time. Considering the size of the market, however, there's plenty of room for both of them to grow into. But the rivalry between the two is only going to get worse.

Future

QuTouTiao's future or at least within the next few years will consist of maintaining the user growth it's currently achieving. It will most likely need to maintain its loyalty program to continue this growth so I would suspect it will continue to be unprofitable for some time. Despite the losses, QuTouTiao is not in a bad position financially. It has over $337 million in cash that has covered all its current liabilities of $161 million. It also has no debt. Furthermore, not long after announcing it would raise $33 million through 3.3 million new ADSs, Alibaba sent a $172 million convertible bond with an exercise price of $15, its way, which it apparently didn't need. Nonetheless, it looks like Tencent and Alibaba are very willing to give QuTouTiao money which will give it considerable support as it continues to expand.

In February of 2018, QuTouTiao acquired an advertising agent. This decision was made because QuTouTiao needed to have a more healthy mix of customers for advertising as it was relying heavily on Baidu, its largest customer for ads. These ads are featured on the side of QuTouTiao's content and are its main source of revenue. So when Baidu lowered their advertising budget, it took a significant hit on QuTouTiao. This agent works on selling advertising solutions to various other advertising agents and end-advertisers. This gave QuTouTiao a much wider circle of connections that allowed it to have a much healthier number of advertisers on the platform.

In June of 2018, 78% of QuTouTiao's revenues came from this agent. As QuTouTiao continues to expand in low-tier cities, it could become the one-stop shop for local advertisers. In a way, it could become the Google Adwords of low-tier cities. Its powerful AI lets it not only create customised content but also customised ads. QuTouTiao's user retention rate also makes it very appealing. QuTouTiao's user base is also varied with 50% of its users under and 50% over the age of 40 and 60% are women, while 40% are men. And if it keeps up its current growth, these local advertisers could be marketing to hundreds of millions of people in rural China.

In the Q4 report released in March of this year, QuTouTiao released a few numbers regarding its expected revenue for the coming year:

Metric

2017

2018

2019*

Revenue

517,053

3,022,146

7,500,000 - 9,500,000

YoY Increase

+777%

+497%

+148% - 214%

*2019 Estimates

QuTouTiao's revenue outlooks for the year ahead (in 000's RMB). Source: ir.qutoutiao.net

The company's management has only mentioned their expectations for the year ahead. Within their guidance, they mentioned first quarter revenues of between RMB1.10 billion to RMB 1.12 billion, representing a 365% to 374% YoY growth, not significantly slower than the 426% growth seen in Q4.

They are expecting strong year-on-year growth momentum for the entire year of 2019 as shown in the table above. While growth is slowing, it's still nothing less than jaw-dropping.

With regard to its users, established social media players can give us somewhat of an idea of what value it could have as it grows its user base and manages to reduce its user acquisition and retention costs:

Social Platform

QuTouTiao

Weibo

Snapchat

Pinterest

Twitter

MAU in Millions

93.8

462

300

265

330

Market Cap

(in $B)

1.6

13.3

14

15.4

28.7

Monthly active users and market caps of popular social media platforms.

Summary

Could QuTouTiao be the next big thing? Source: cbinsights.com

In summary, over the past few months, QuTouTiao has caused mixed emotions within investors. Its unusual user acquisition technique of financial rewards which led to widening losses caused a major selloff despite revenue skyrocketing 426%. While those same risks still persist, the major sell-off has created immense value in the stock. Just picture this: a stock generating $500 million in revenue yearly and expected to grow by 181% in the coming year is valued at just $1.6 billion? Crazy isn't it? QuTouTiao has incredible long term growth that has been shadowed by short term fears. With over a billion people in rural China and a competitor with over 240 million MAU, QuTouTiao has plenty of user growth ahead from its current 93 million MAU. Increasing monetisation, the gradual decline of user acquisition and retention costs combined with the growth of secondary apps (like Midu) makes QuTouTiao a once in a lifetime buy.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in QTT 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.