Momo Inc. Analysis

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Momo Inc. Analysis

Momo (Ticker: MOMO) has had a rough couple of months in the public markets.

Momo is a Chinese domiciled mobile social and entertainment platform. The firm enables “users to connect with each other and expand relationships from online to offline” through live videos, short videos, social games and other video/audio based interactive experiences. Revenue is generated from “live video service, value-added service, mobile marketing, mobile games and other services.” I think of Momo as a Chinese YouTube with added features like live chat, multiplayer games and a virtual gifting feature which brings in the bulk of the revenue base. As of 9/30/18 Momo had a monthly active user base of 110.5M.

The morning of their 2018Q3 release on Thursday, I checked MOMO’s headline numbers. In the hours before the opening bell, and I felt like the firm performed very well financially compared to 2017Q3 (known as a year over year comparison or “YoY”). The headline number many are preaching is the 51% revenue growth (YoY) to $536M.

MOMO Income Statement

 

Source: Morningstar

On the negative side, guidance for the last quarter of 2018 came in a tad below what the average street analyst had estimated. I assumed: that the R&D expenses would rise (they did), and that the firm’s business expansion and acquisition of TanTan would add other various costs that would eat away at the revenue base (costs did increase across the board). So I wasn’t shocked to see a smaller net income growth figure of 7.6% YoY. As you can see in the graphic below from Morningstar, the net income margin was lower in 2018Q3 as a result of the increased costs of the Tantan acquisition and general business expansion.

MOMO Net Income

 

Source: Morningstar

Also on my mind was what I see as a main threat to a Chinese tech stock in the current environment, which revolves around the important international trade negotiations on the horizon, which will certainly influence the global economy.

Even with the disappointing guidance and weak bottom line growth, I thought that the decline in the stock price from about $33 on Tuesday to $24.5 by the end of Friday’s session was undeserved from the top-level factors I was weighing. Watching the shares tick down over the past two days, I did not have the time to look into potential reasons for the decline until after work today.

Finally, I have gotten the chance to look at the income statement, balance sheet and cash flow statement in the 2018Q3 6-K MOMO reported Thursday morning. Everything appeared kosher until I arrived at the cash flow statement and the story quickly grew dark. The firm’s cash flow from operations (CFO) is less than half of what it was for the quarter of 2017Q3 (falling from $105M to $51M), and this is mainly due to the revenue recognition occurring. The firm’s accounts receivable line item is up nearly $62M; this is money that customers owe to the firm but the firm has already accounted for the sales and costs of those sales on the income statement.

MOMO Accounts Receivables

 

Source: Morningstar

Taking a look at the screen grab from Morningstar, this is by far the largest change in the firm’s accounts receivable in the past nine quarters. The CFO figure attempts to look at the actual cash generated from operating activities. Since no cash was collected on the $62M in credit sales, the CFO figure is not as positive as it would have been had those sales been made without offering credit. While MOMO has less cash at its disposal, the firm’s increase of credit to customers is not necessarily a negative for the firm. The allowance for doubtful accounts is zero; meaning the firm projects to collect all that is owed to it. The firm did spell out this decrease in CFO and provide a reason for it, “The decrease in the operating cash flow for the quarter was primarily because revenues from the TV show Phanta City still sit as accounts receivable on the balance sheet while related costs have largely been paid.”

With top line growth still very positive and investment into the firm through both acquisitions and R&D spend, I think that there are still a lot of positives left to come from Momo. For instance, net income growth is up 50% in the nine months through 2018 compared to the first nine months of 2017. TanTan, the Chinese dating application that Momo purchased earlier this year is growing nicely. In 2018Q3 Tantan reached 3.6M in paying customers (Tantan had an average monthly revenue increase of 77%) and added 500K users in the quarter. Compare this to Match group which reported 8.1M average subscribers in their last quarter. With an addressable market of 300M millennials in China, the growth on this segment could be substantial in years to come.

Even with increased investing activity, setting the firm up for continued growth in the future, the commonly addressed price multiples are still quite attractive compared to peer average levels.
Below are three screen grabs from Morningstar. The first is showcasing the substantial increase in investing activities. The second is showcasing how that investment has decreased free cash flow for the time being. The third picture is a relative valuation compared to industry averages.

MOMO Current Valuation

 

Source: Morningstar
Figure 1

MOMO Investing Activities

 

Source: Morningstar
Figure 2

MOMO Free Cash Flow

 

Source: Morningstar
Figure 3

Momo has a trailing 12 month P/E of 12X and a forward P/E of 7.6X; the firm is very attractive when looking at these earnings multiple figures compared to the S&P500 which has a trailing P/E of 18.8X and a forward P/E of 17X. It seems that investors and analysts are paying more attention to the cash flow figures however. Momo had an average price to cash flow ratio of 11.5X over the last 3 years, compared to the S&P which had an average 12.8X price to cash flow ratio. While the price to cash flow figure was negatively impacted by the latest quarter, it is still more attractive than the S&P500. Lastly, I’d like to point out the PEG ratio. The PEG ratio is a ratio of the firm’s P/E ratio to the earnings growth of the firm. With a trailing P/E of 12 and a net income growth rate YoY of 37.84% (2018Q3 T12M EPS $2.04 versus 2017Q3 T12M EPS of $1.48) the PEG ratio comes in at 0.3X. Normally a PEG ratio under 1 is an indication that a stock could be priced cheap compared to its growth. Nonetheless the shares have taken a beating. Morgan Stanley downgraded the stock from overweight to equal weight and cut their price target from $61 to $30.
https://seekingalpha.com/news/3415254-morgan-stanley-slashes-momo-target-earnings.
While the stock has its threats, I come away thinking that the valuation is attractive here and may even be considered a value stock given the favorable ratio comparisons outlined earlier. I’m holding my shares and continuing to watch closely for signs of further cash flow deterioration.  

Sources:

  1. Tantan acquisition article: https://www.bloomberg.com/news/articles/2018-02-23/china-s-momo-to-acquire-smaller-tinder-like-rival-app-tantan
  2. SEC filing of 2018Q3 6-K: https://www.sec.gov/Archives/edgar/data/1610601/000119312518343009/d626983dex991.htm
  3. SEC filing of 2017Q3 6-K: https://www.sec.gov/Archives/edgar/data/1610601/000119312517353938/d497870dex991.htm
  4. SEC filing of 2017 20-F: https://www.sec.gov/Archives/edgar/data/1610601/000119312518133102/d504595d20f.htm#rom504595_7
  5. SEC filing of 2017 20-F: https://www.sec.gov/Archives/edgar/data/1610601/000119312518133102/d504595d20f.htm#rom504595_7

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