We initiate coverage on Meituan Dianping given our long experience of covering Chinese stocks. The company recently went public on Hong Kong Stock Exchange as a very high profile tech IPO last Sep given its decacorn status pre-IPO. Its IPO generated US$4.2 bn in proceeds, with market cap of US$52.8 bn at its IPO price (HK$69/share). Given its sheer size, Meituan is clearly one of Chinese tech heavyweights worth covering, like the famous China’s BAT (Baidu -BIDU-, Alibaba -BABA-, and Tencent Holdings –OTCPK:TCTZF-). Meituan’s daily average turnover on Hong Kong Stock Exchange (trading with ticker symbol of 3690) is a huge US$150 mn over the past 90 days. Its OTC ADR (OTCPK:MPNGF) trades at a decent US$3-4mn/day on average.
Prime beneficiary of the latest online consumption boom
The main top-down thesis of investing in Meituan is that the company is in a sweet spot of China’s online consumption boom. As a side note, when we refer to online consumption, it means consumption transacted on both website/PCs and mobile/smartphone devices. Specifically, Meituan benefits from a big consumption trend in China where consumers are shifting into service/experiential consumption, from goods consumption.
In our coverage of Chinese consumption space, over past decade, we note three big trends: 1) a shift of goods consumption from offline to online platforms 2) premiumization/consumption upgrade for better quality and 3) a shift into service/experiential consumption. Hence, as stated, Meituan is the prime beneficiary of the third trend. As a comparison, BABA is the prime beneficiary of the first trend and second trend to some extent (through its Tmall platform).
In fact, when we compare Meituan’s core business revenue (classified as food delivery and in-store, hotel & travel segments, more on this later) with BABA’s core commerce segment (where its dominant e-commerce platforms Taobao and Tmall lie), we find Meituan has strikingly followed BABA, growth path-wise (of course with Meituan trailing in terms of year/timeline). For example, in 2016 (FY for Meituan ending in Dec), Meituan’s core business revenue was Rmb12 bn. Two years later, in 2018, this core business achieved Rmb54bn revenue. As a comparison, BABA’s core commerce revenue in FY14 (ending in Mar) was Rmb50 bn, growing from Rmb19 bn in FY12.
Hence, Meituan’s core business, cycle-wise, is approximately where BABA’s core commerce was in FY14. Looking out three years later into FY17, BABA’s core commerce segment posted Rmb134 bn, 2.7 times FY 14’s level or an astounding 39% CAGR. So, assuming Meituan’s core business to follow BABA’s core commerce, growth path-wise, in 2021, Meituan’s core business revenue would be Rmb130-140 bn or US$20 bn.
Consumer service oriented business
Both Meituan and BABA are essentially e-commerce platform businesses. The big difference is that Meituan is consumer service oriented business, vs. BABA’s predominantly goods such as apparel, footwear, and consumer goods including electronics. Specifically, Meituan derives its revenue from two core businesses classified into 1) food delivery and 2) in-store, hotel & travel (ISHT) segments. In food delivery segment (56% of sales), Meituan is basically China’s GrubHub (GRUB) but with the former eight times the latter, size-wise. Meituan’s GTV (Gross Transaction Value) for food delivery is Rmb283 bn (US$42.7 bn) in 2018. The equivalent figure for GRUB is only US$5.1 bn.
Profitability-wise, Meituan’s food delivery lags GRUB as the former built and currently operate huge on-demand food delivery networks (over 500K active delivery riders to serve over 3 mn restaurant merchants). The company only discloses GM (no OM disclosure) for the segment, which is only 14% in 2018 (vs. GRUB’s 50% GM). However, we note that going forward, Meituan has more room for GM improvement given much lower take rate and realization of economies of scale. In fact, a year earlier in 2017, Meituan’s food delivery GM was only 8%. Moreover, the huge on-demand food delivery networks (in spite of greater opex) also serves as a huge barrier to entry, resulting in duopoly structure for China’s online food delivery market (Meituan has 55% MS, followed by BABA’s food delivery arm called ele.me with 36% MS). In the U.S., online food delivery market is much more fragmented, with GRUB commanding only 35% MS as the largest player.
Furthermore, Meituan’s ISHT (24% of sales) is China’s Groupon, Booking Holdings, Expedia and Yelp combined into one. According to management, top three service categories used by consumers in the ISHT segment are in-store dining, hotel booking, and beauty (spa, wedding services, and salon services). This segment is very profitable, with GM at 88-90% level. This is because the vast majority of ISHT segment users come from food delivery (those already using food delivery services a few times first). Hence, management explained that, in terms of accounting, user acquisition costs were borne by food delivery segment.
Core business profitability improving substantially
As mentioned earlier, we consider food delivery and ISHT as Meituan’s core business since the third/last segment is new initiatives & other (mainly consisting of 1) bike sharing platform called Mobike that was acquired in Apr 2018, 2) ride hailing, 3) non-food/groceries delivery, and 4) restaurant management system sales). As the company only discloses segment reporting at GP level, we dive deeper into OP segment by combining food delivery and ISHT as one segment. In our opinion, such simplified segmentation is appropriate as Meituan’s business model is to monetize ISHT with high user traffic brought by food delivery. Moreover, the simplified segmentation substantially lowers margins of error in allocating opex as we only have two segment lefts.
Based on the simplified segmentation, we estimate that OM for core business (combined food delivery and ISHT) was -5.7% in 2018, a 820 bps YoY improvement. The better good news is that in 1Q19 results announced two weeks ago, this core business finally posted a small profit (Rmb105 mn GAAP OP or 0.7% OM). This is mainly driven by continued realization of economies of scale (from much higher GTV) and higher take rates (higher delivery fees for food delivery). As for further realization of economies of scale, we can see that on a consolidated basis, opex to sales ratio continued to decline to 35.6% in 1Q19, from 43.4% in 1Q18. It is worth noting as well is that in 2016, opex/sales ratio was as high as 95% before it dropped substantially to 49.3% in 2017.
Going forward, the key question is if 1Q19's small profitability generated by core business would be sustainable amid heightened competition from ele.me. Note that BABA fully acquired ele.me (from previously 43% stake) in May 2018 and has been aggressive on consumer subsidy/promotion to acquire users especially in lower tier (Tier 3 and Tier 4) cities. During the latest earnings call, management was confident that the heightened competition from ele.me would not cause too much of upheaval in terms of consumers subsidy level. Moreover, management does not think that the hefty subsidy offered by ele.me would last more than 6-12 months as BABA is well aware of duopoly industry structure.
In particular, Meituan does not match ele.me’s subsidy level dollar for dollar (only counter the subsidy selectively). Management’s primary reasoning is that Meituan has established strong branding/mind share when it comes to on-demand food delivery app especially in Tier 3 and Tier 4 cities while ele.me is only beginning to penetrate into Tier 3 and Tier 4 cities. Moreover, management thinks that restaurant industry is so fragmented (millions of merchants plus various food choices) providing a benefit that subsidy is hard to compare on an apple to apple basis. In fact, some customers already have their food/restaurant choices in mind before ordering in on-demand food delivery app.
We think management’s explanation (consumer subsidy level should be manageable) makes some sense. In fact, based on 1Q19 results, food delivery’s GM was 14.4%, 100 bps and 60 bps improvement over 4Q18 and 2018, respectively. Moreover, the slight improvement in 1Q19 GM for food delivery indicates that competition especially from ele.me has been more manageable than anticipated.
New initiatives reducing losses
Another good news from 1Q19 earnings call is that management has managed to reduce big losses from new initiatives & others (17% of sales). Gross loss (not GP) for new initiatives & others stood at Rmb440 mn in 1Q19, narrowing from Rmb979 mn/Rmb1.3 bn/1.9 bn in 4Q/3Q/2Q18. We don’t compare 1Q19 with 1Q18 (only Rmb79 mn gross loss) as Mobike (the primary cause for ballooning losses in new initiatives & others) was consolidated in Apr 2018. Our operating loss estimate for new initiatives & others in 1Q19 was Rmb1.8 bn, also narrowing from Rmb2.6-4.3 bn operating losses in 2Q-4Q18.
Management attributed the narrowing loss for new initiatives & others to restructuring of Mobike (more disciplined investments and closure of overseas operations), reduced consumer subsidy for ride hailing operations, and operating leverage of groceries delivery operation. Furthermore, we like what we heard from management during 1Q19 earnings call. Management stated that it would continue its disciplined investments for Mobike. In addition, as for ride hailing operations, starting in Apr, management has focused on marketplace business model, which is to connect users with third party car rental companies (no investment in self operated car fleets and drivers). Moreover, the ride hailing operation scale would be kept at a certain level (no heavy investments into new cities). We are supportive of management’s measured expansion plan and market place business model (a lot more cost efficient, in our opinion).
Path to profitability clearer
With core business turning into a small operating profit and much reduced losses for new initiatives & others, Meituan recorded the first ever positive adjusted EBITDA in 1Q19 (Rmb459 mn, vs. Rmb1.1 bn/Rmb4.7 bn adjusted EBITDA loss in 1Q18/2018). Consensus though still projects adjusted EBITDA loss of Rmb1.3 bn for 2019, then positive EBITDA of Rmb7.5 bn in 2020E. This indicates that consensus has low expectations for Meituan’s EBITDA progress, which is good news as the room for consensus figure upgrade is quite big especially judging on 1Q19 results. In other words, we think consensus’ low expectation implies positive earnings surprise are in the offing. Regardless of whether consensus projection is too conservative, we opine 1Q19 results show that path to profitability for Meituan is clearer.
Conclusion and valuation
The main attraction of investing in Meituan is that the company, especially through food delivery and ISHT segments, is a prime beneficiary of the latest online consumption boom (a shift into service/experiential consumption). In other words, Meituan today is the “Next Big Thing” like BABA back in FY14 where the latter enjoyed 39% CAGR in core commerce revenue the following three years (FY14-FY17), thanks to a shift of goods consumption from offline to online platform. Moreover, the core business has seen its profitability improve substantially. In fact, 1Q19 OP (our estimates) for core business has reached profitability first time ever. Going forward, we think that core business’s small profitability should be sustained as competition from ele.me has been more manageable than anticipated. Also, management has been a lot more disciplined in reducing losses for new initiatives & others. All in all, the core business’ small profitability and reducing losses for new initiatives & others implies that path to profitability for Meituan is clearer.
Valuation-wise, given negative net earnings projected by consensus until 2020E, we believe that the market is willing to value Meituan on a P/S multiple mainly on the basis that Meituan is a dominant service e-commerce play (with a good chance that its dominance would allow the company to eventually post net profit). Meituan trades at 3.3x 2019E P/S, a 22% discount to average Chinese big cap internet peers and a 31% discount to BAT. Assuming 4.3x 2019E P/S (average Chinese big internet peers), the 12-mo PT for Meituan would be HK$77/share or US$9.80 for its OTC ADR, implying 26% upside potential. Thus, we initiative coverage on Meituan Dianping with a Buy rating.
Disclosure: I am/we are long GRUB. 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.