HUYA: A Deeply Discounted Turnaround Play

Aug. 31, 2022 1:48 PM ETHUYA Inc. (HUYA)22 Comments
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  • HUYA clears a very low bar this quarter, as massive cost cuts get its bottom line back to black.
  • With the impact of tightened regulations set to kick in over the coming months, however, the earnings outlook is cloudy.
  • But management is moving in the right direction, and with the stock trading below net cash, the investment case is compelling.

eSports player competing at an eSports event

Marko Geber

HUYA's (NYSE:HUYA) better-than-expected Q2 2022 margin result was a positive surprise, but the near-term outlook remains far from rosy given the pending regulatory impacts and rising content costs heading into the back half of the year. With more conservative monetization also on the cards, HUYA is likely on track to record more losses in H2 2022 before signs of a turnaround materialize. That said, HUYA remains the industry leader, and in contrast with key peer DouYu (DOYU), management is committed to long-term content investment (albeit more ROI-driven) to defend its competitive position in game live streaming. The company also continues to roll out new community features and is constantly on the lookout for future monetization opportunities from game operations and publishing - while the outcomes of these initiatives are yet to be seen, the strong intent and innovation pipeline are key positives, in my view.

Net, this is still a stock that faces a range of headwinds in the coming quarters, including a macro slowdown, regulatory hurdles, and uncertainties from a changing overseas strategy. Yet, there is a wide margin of safety here, given that the stock is deeply discounted and trades below net cash. Plus, HUYA's leadership position in terms of MAU and eSports content remains intact, while the competitive dynamics are improving with the scaling back of content investment throughout the industry. Assuming a more rational content cost backdrop materializes, patient, long-term-oriented investors stand to benefit from an FY23 margin recovery, which should, in turn, re-rate the stock.

HUYA Market Cap
Data by YCharts

Outperforming Very Low Earnings Expectations in Q2 2022

Livestreaming revenue fell ~20% YoY to RMB2.05bn this quarter amid worsening paying sentiment and lower user spending, as well as the implementation of tighter regulations. Revenue from advertising was down a steeper ~42% YoY, also due to the macro headwinds weighing on advertising spend, while sublicensing revenue fell YoY on delayed scheduling. Management also scaled back on its overseas operations, leading to the paying user base shrinking ~5% QoQ to 5.6m while the average revenue per paying user (ARPPU) was flat QoQ (but down 20% YoY) due to the weaker consumption sentiment. There were some positive takeaways, though - even with ~35% fewer licensed and self-produced tournaments organized this quarter, HUYA's content viewership only fell ~10% YoY, implying more popularity on a per-show basis. HUYA's mobile MAU also grew strongly at 8% YoY (a divergence vs. DouYu's down 8% YoY) and total user time spent was up ~12% YoY. Next-month retention rate also remains at a solid >70%, signaling the stickiness of the HUYA platform.

HUYA Q2 Revenue Summary


In contrast to the YoY revenue decline, HUYA massively outperformed expectations by remaining in the black with a 0.3% adjusted net margin. Of note, this result came despite gross margin declining to 9.6% (vs. 14.1% in Q1 2022) due to increased revenue sharing contribution and higher content costs. The key was in the adjusted EBIT line, which saw a narrower than expected RMB56m loss, driving non-GAAP operating margin to -2.5%. Most of the opex savings came from sales and marketing cuts, as management's efforts to fine-tune its marketing ROI and scale back on its overseas presence look to be paying off. While regulation (enacted in June) was the key concern heading into earnings, the overall impact proved to be less-than-anticipated, not only thanks to opex savings but also monetization enhancements via value-added features in live streaming rooms (e.g., Super Fans/VIP subscription plans).

HUYA Q2 Margin Summary


Near-Term Outlook Remains Shrouded in Uncertainty

Heading into Q3, HUYA's live streaming revenue could see sequential declines as the full quarter regulatory impact kicks in. Recall that China had implemented a series of regulations with the intention of standardizing online live broadcast rewards and protecting minors (specifically targeting peak playing sessions and tipping) effective June. While the new rules will impact the industry as a whole, incumbents such as HUYA and Hello Group (MOMO) are seeing relatively bigger impacts due to their higher exposure to top streamers and 'whale' spenders. HUYA has already made the necessary product upgrades, though, so the impact on the core user base and revenue has been less than expected in Q2. This could well continue in the coming quarters as well, given the high-quality content on the platform as well as its more efficient compliance capabilities (e.g., a real-time AI sound silencing system), allowing it to filter out inappropriate content without disrupting the user experience.

On the cost side, HUYA's ability to enhance operational efficiency and implement effective cost controls has been a key highlight. In particular, the ROI focus on marketing and tournament procurement/development, as well as the scale back of overseas operations, have yielded solid results. Yet, the path to structural profitability will take time. Content cost, in particular, will be a key swing factor given HUYA's focus on top licensed tournaments, which tends to take longer to re-price. More broadly, signs of easing competition intensity have been positive - for instance, the exit of Penguin Esports and DouYu's shift toward self-produced tournaments could lead to a more rational pricing outlook down the line. Similarly, revenue sharing presents a source of margin upside, as peers have pulled back across the industry, potentially boosting HUYA's flexibility in 2023 and beyond.

Long-Term Upside from the Buildout of New Revenue Streams

On balance, HUYA retains its competitive position as the go-to eSports platform. Yet, the company isn't resting on its laurels, continuing to build out a highly-engaged ecosystem around its content and community to unlock long-term monetization upside. The version 10 upgrade, for instance, comes with a 'Tiger Chit-Chat' (虎扯) function allowing for discussions between fans and streamers even when not streaming. Other medium-to-long-term monetization levers include revenue sharing of gross billings with game studios for long-tail game titles, short video ads, and interactive games within the live streaming rooms. These initiatives are key over the long run, as more stringent live streaming tipping regulations emphasize the need for diversification and new revenue streams. It's still early days but the efforts to develop a better commercialization model and seek monetization opportunities are steps in the right direction, in my view, as HUYA seeks to get live streaming revenue back to a positive growth trajectory.

A Deeply Discounted Turnaround Play

Turnarounds take time, and HUYA is no different, particularly given the scale of the industry challenges ahead. Tighter live streaming regulation (effective June), for instance, is set to disproportionately impact incumbents, like HUYA, given their exposure to top payers and streamers, while the macro weakness could weigh on consumer sentiment as well (online entertainment spending is after all, discretionary).

That said, there are silver linings - while game streaming has long been plagued by high tournament procurement and content costs, HUYA's cost optimization initiatives already seem to be paying off. Plus, the industry is cutting back on content investments, paving the way for a more rational environment into FY23 and beyond. Coupled with improving growth momentum, as consumer sentiment eventually improves along with HUYA's continued cost optimization efforts, a margin recovery could be in the cards sooner than expected. At current levels, investors get a wide margin of safety - HUYA stock is already trading at a discount to net cash, providing downside support even if the earnings downcycle takes longer to bottom out.

This article was written by

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A passionately curious analyst.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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