YY (NASDAQ: YY) continues to show very strong top line and user growth, but costs are rising even faster. Does the low valuation and news of a share buyback imply further upside to come?
The Chinese social media company reported a solid set of second-quarter results last week. Investors are no doubt hoping this will signal the end of the 18-month downtrend that has seen the stock price fall from $140 to $51.
The company reported revenue growth of 66.8% to $917 million which was $38 million better than expected. Non-GAAP EPS also beat expectations comfortably, coming in at $0.75. However, GAAP EPS were well below expectations at $0.04 as a result of a string of non-cash expenses.
Subscriber Growth Across All Platforms
YY experienced strong growth in users across multiple platforms including the recently acquired BIGO. Total MAUs reached 433 million, including 90 million for short-form videos, 141 million for mobile live streaming and 212 million for the instant messaging platform IMO.
Live streaming contributed 94.1% of total net revenues of which mobile contributed 71.7%. This illustrates that while the company is seeing user growth across multiple platforms, it’s live streaming that is generating the revenue.
Costs Rising Faster than Revenues
The cost of revenues increased by 80% year-over-year. This includes revenue-sharing fees and content costs paid to performers, guilds, and content providers. So, while revenue grew 66%, gross profit only grew by 45%. The gross margin also fell as the lower margin Huya and BIGO platforms were incorporated.
Sales and marketing expenses jumped 350% from 6.5% to 17.5% of revenue. Most of the increased spending was in overseas markets where YY is trying to establish a foothold.
Management indicated that they plan to reduce spending in the future and see the second quarter marketing spend as an investment. For the third quarter, the company expects revenue growth to slow slightly to between 60 and 65%. In addition, a $300 million stock buyback program was announced.
The Bear Case Is in the Price
The bear case is easy to see. While revenue is rising, costs are rising faster – both content costs and marketing costs. YY is now relying on overseas markets for growth but has yet to prove itself in those markets. The company is diversifying its product offering but is still heavily reliant on the live streaming business for revenue. In addition, all of YY’s platforms operate in very competitive markets.
There is also a bull case to be made. First, the stock is oversold and very cheap when compared to its peers and its own historical multiples. The heavy marketing expenditure is an investment in building market share. The company is well diversified and the probability of one or more product gaining traction globally is good. The share buyback will also support the price.
Will the Business Strategy Pay Off?
The $4.4 billion question is whether growth continues without the current level of spending? The market will only know that in the next few quarters, if or when marketing spend is reduced.
Until then the risks at current levels are probably limited. The stock price has been beaten down to such an extent that most current holders must be in it for the long haul. The stock price reacted well to the results during the weakest week global markets have seen this year. Using $50 as a stop loss means downside is limited, while there could be significant upside if the market buys into the story again, or if YY’s business strategy works out over the next few quarters.