YY – Growth at a Cheap Price

NASDAQ: YY / Price: $70 / Market Capitalization: $4.5 billion / Thesis: Social Media Compounder

YY is the #1 Chinese live streaming platform with two partially-owned subsidiaries, Huya and Bigo Live. YY‘s core business specializes in Chinese general entertainment live streaming whereas Huya specializes in Chinese game live streaming and Bigo Live specializes in global live streaming.

The current consensus in the market is that live streaming is a fad and the live streaming industry does not have any barriers to entry. Although there are some truths to these statements, the general perception ignores the recent development in the live streaming industry and YY’s dominant positioning. Overall, YY’s live streaming is still a good business with defensible barriers to entry.

At the current price, an investor in YY is getting a leading Chinese live streaming company for a low single digit multiple, a majority stake in a Chinese oligopolistic game live streaming company, and a minor stake in a global live streaming company with tremendous upside. All three companies are growing at a fast pace and all have a defensible position in their respective niche. Adding everything together, YY is currently trading at 50 cents on the dollar and is getting far cheaper with time.

Business Model

Before getting into the specifics about YY, the attractiveness of live streaming must be first explained. The live streaming business model that YY pioneered is incredibly attractive because it is a well-structured platform with an enticing incentive system.

In essence, live streaming is an interactive television platform. On one side of the platform, there are the streamers or content creators. On the other side of the platform, there are viewers or users of the platform. The streamers perform acts and entertain viewers. In return, viewers tip streamers with virtual gifts for their performance. The platform facilitates the interaction and takes a significant cut (usually around 40%) of the virtual gifts.

Platform

Within this process, there are many strong social phenomena behind the scenes. Throughout a live streaming session, the streamers and viewers create a rapport with each other. The viewers then wants to reciprocate and tip the streamers. Because the tip is shown prominently on the screens, the tipping gives an instant gratification to both the tipper and the streamer. The act reinforces the tipper’s commitment to the streamer and reinforces the streamer’s commitment to the tipper. As more viewers watch a streamer, the interaction from viewer to streamer gets crowded out and becomes more tip-based. As more viewers tip, the tipping process becomes competitive and creates an auction for the attention of the streamers.

Live streaming possesses attractive economics because it is tip-based and capital light. The tipping monetization allows the platform to generate more revenue on a per user basis than other forms of monetization such as advertising. This is because the tipping is competitive, is an auction for the streamer’s attention, and can be profitable with just a fraction of the users. In fact, according to different sources, a live streaming platform can be self-sustainable with only the top 4% of the users. Thus, as long as live streaming platforms can maintain its heavy tippers, they can generate excessive profits from the tips.

Business

YY was first founded in 2005 as a game portal, but has shifted its business model in 2012 to live streaming. Since then, its live streaming business has taken off and became its main revenue driver. Apart from its core Chinese live streaming business YY Live, YY has a 44% ownership stake in Huya with majority voting rights and a 30%+ ownership in Bigo Live with the option of purchasing up to 50.1% by mid-2019.

YY Live: Cash Cow

YY Live is the leading Chinese live streaming platform with verticals in music, dance, talk show, outdoor activities, sports, and anime. From 2012 to 2019, YY Live pioneered the current live streaming monetization model and grew its live streaming business from zero to $1.5 billion in annual sales. As the live streaming industry in China slows down from its hyper growth stage, YY Live is transitioning from a high growth company to a defensive cash cow. YY Live is solidifying its dominant position in the industry by creating exclusive partnerships with talent agencies, partnering with other live streaming platform like Xiaomi Live, and increasing its investments in content production and curation. These actions are building a wider moat around YY Live with higher content stickiness, higher content quality, and greater scale.

Huya: Tencent Consolidation

In 2014, Huya was spun out of YY to solely focus on Chinese game live streaming. The main reason for the spin-off was that YY required gaming broadcasting rights from gaming companies but had competitive conflicts with some gaming companies like Tencent. Without those rights, it would be hard to legally live stream the game play and hard to compete with competitors with the proper broadcasting rights. As a result, in July 2017, YY partnered with the dominant player in gaming Tencent, sold a 34.6% Huya to Tencent for $461.6 million at a huge discount to the current market price, and gave Tencent the right to acquired up to 50.1% of Huya shares at the 20 day average market price between March 8, 2020 and March 8, 2021. In essence, YY sold the majority of Huya to Tencent at a discount to ensure Huya’s long-term competitive positioning in the Chinese game live streaming industry.

According to interviews with YY’s CEO and founder, Tencent intends to consolidate the game live streaming industry by merging its investees Huya and Douyu. This should not be a surprise since Tencent has consolidated its markets multiple times in the past. Tencent Music is probably the best example of Tencent’s playbook. Tencent consolidated all of the players in music streaming and created a vertically integrated monopoly in music, capturing the whole music streaming profit pool in China.

 “I think the final situation is Tencent games will combine with Douyu and Huya together and form one whole. This company will also make games and game broadcasting just like you own NBA teams and own ESPN. You make all those things together as a very powerful ecosystem.” – David Li YY’s CEO and Founder

Bigo Live: Worldwide Expansion

“YY is one of the few China products, we believe, that has a chance to make it as a global product. It’s a matter of timing.” – David Li YY’s CEO and Founder

Bigo Live was first founded as a free international call service within YY. Because Bigo Live was burning a large amount of money in its infancy, YY spun off Bigo Live into a separate company in 2014 to mitigate the start-up’s huge losses while retaining a minority stake. Since then, Bigo Live has shifted from internal call service into international live streaming. Within less than 4 years, Bigo Live has utilized YY’s playbook and became one of the top grossing apps in the world with more than 200 million registered users. According to the management, Bigo Live generated more than $600 million in revenue in 2018, already breaks even, and expects to double its revenue within the next year. Now that Bigo Live is extremely successful, YY wants to reconsolidate Bigo Live’s results into its financials. YY has an option to purchase up to 50.1% of Bigo Live by mid-2019 and consolidate Bigo Live’s financials onto YY’s financials. According to YY’s CEO, YY intends on exercising that option and consolidate Bigo Live within YY. Given live streaming is still in its infancy in international markets, Bigo Live has a clear blue sky opportunity and can benefit YY’s financials tremendously. To illustrate the opportunity at hand, India, Middle East, and South East Asia could all have a live streaming industry as lucrative as the Chinese live streaming industry.

Variant View

The current consensus view on YY Live is that live streaming is a fad, YY Live will not be able to compete effectively with other live streaming platforms, and regulations will hurt YY Live’s fundamentals. While these are concerns all have some truths behind them, they are mostly overblown.

First, live streaming is a resilient media niche that is here to stay. Just like live sports and live events, the raw social element of live streaming is valuable and stands out in the media era of “what you want, when you want it, where you want it”. Even though live streaming may not become mainstream, its content will continue to appeal to a niche audience that is seeking fulfilling interactions online. In China alone, live streaming is likely to grow 20%+ CAGR for the next few years from the increase in demand for live streaming.

Projections

Second, there is a misconception that other streaming platforms will eat YY Live’s lunch. The pure live streaming industry in China has already matured and consolidated to a few key players. The last major live streaming company was created in 2015. Since then the only successful entrants to live streaming have been companies that do not focus on live-streaming. Instead, they would focus on other areas and add live streaming as a monetization tool. Take Momo or Tencent Music Entertainment for example, they operate a dating or music streaming platform as their core business but use live streaming as a way to further drive its revenue. Thus, the competition is not as direct as the consensus suggest.

Third, dominant live streaming platforms have started to form exclusive contracts with talent agencies. Similar to the talent agencies in Korea, the streamers now sign a multi-year contract with live streaming platforms and have strict commitments with live streaming platforms. Streamers can improve their popularity with other media platforms, but they are obligated to live stream with YY. This exclusivity will constraint top streamers from moving onto other platforms and enhance the stickiness of the live streaming platforms. As a result, the platforms with the largest scale in live streaming (ie. YY Live) have the largest number of exclusive streamers and strongest competitive advantages in terms of scale and network effects. Similar to Netflix, YY is building its competitive advantage with investments into scale with exclusive and personalized content.

Fourth, live streaming platforms like YY still have untapped pricing and untapped market potential. The consensus often ignores the fact that paying users and tips are the main drivers of live streaming economics. Instead, a heavy emphasis is put on overall viewers and overall popularity. Even if YY Live decreases in popularity, YY Live can continuously innovate its platform to drive number of paying members and the amount each paying members pays. For instance, contests, competitions, and events can all increase YY’s paying users and tip per user.

Fifth, Chinese regulations can actually benefit large live streaming platforms such as YY since they raise the regulatory barriers to entry. More requirements in technology and human capital to comply with the regulations will inevitably increase the costs of operating a live streaming business and drive out the smaller live streaming platforms. This phenomenon is already happening as live streaming platforms are shutting down across China due to regulation.

Management

YY is owned and operated by a visionary entrepreneur, David Li. To this day, David Li still owns 15% of the company, has majority control, and operates YY as the CEO and Chairman. So far, he has a great track record of innovating and operating YY. He continuously shifted the YY’s business model until he single-handedly pioneered the current live streaming industry model. He has since consolidated YY’s position in live streaming, partnered with Tencent to form a monopoly in game live streaming, and is now exporting the live streaming business model across the world. Every single major business development decision has been spot on and executed flawlessly.

In terms of capital allocation, YY’s management team does not have a long track record of capital allocation since YY is still growing and is still reinvesting its capital back into the business at a high rate of return. Outside of reinvestments, YY has been opportunistic with its capital by buying back its shares in 2015 when its shares were depressed and making some shrewd investments into related companies (ie. Tantan).

Valuation

By excluding YY’s stake in Huya, YY is trading at around 2.5x EBIT. This low multiple completely absurd for a leader in a growing industry with growing competitive advantages.

Current Valuation

Conservative Valuation

YY Live

YY Live can sustainably generate $400 million in earning power for the foreseeable future. YY Live should also trade at around its historical 10x EBIT as it is still growing its live streaming business at around 20%+ year over year and building a wider moat around its business.

Compared to its competitors such as Momo, Weibo, or AfreecaTV that trades above 15x EBIT, YY Live still looks like an absolute bargain at 10x EBIT.

Huya

Huya is trading at a fair value at the current market capitalization of around $4 billion. Assuming that Huya can grow alongside the game live streaming industry at a rate of 30%+ CAGR for the next five years, can reduce its excessive incentives to streamers, and can scale as efficiently as YY Live, Huya is still trading at more than 30% discount from the current market price and is only trading at around 8x its 2023E conservative EBIT.

Bigo Live

I think based on the valuation maybe YY does not have the ability to acquire BIGO anymore because BIGO’s business is growing very fast. – David Li YY’s CEO and Founder

By the most conservative data points and channel checks, Bigo generated $600 million in revenue in 2018 and broke even in 2018. Bigo Live could be worth as much as Huya since their fundamentals are quite similar. They have similar sales level, break-even point, and large total addressable markets.

Once YY acquires up to 50.1% of Bigo Live and consolidates Bigo Live’s results into its own financials, YY will likely get a large multiple upgrade. YY will likely show accelerated growth and great financial performance after the consolidation.

Using those conservative assumptions, YY is trading at 50% discount to its intrinsic value on top of compounding its intrinsic value at a fast rate over time.

Potential Valuation

Private Market Valuation

In 2015, David Li proposed to take YY private at a valuation of $3.7 billion or $68.5 per ADS. Given the current shares are trading near the take-over price, there is some downward protection at the current price.

Hedge Strategy

Alternatively, an investor can short Huya and only be exposed to the cheap YY Live business, Bigo Live minority ownership, and cash and cash equivalent.

Risks

Disruption Risks – Live streaming could be potentially disrupted by newer forms of media. Secular disruption could happen with newer distribution or monetization models.

Key Man Risks – YY’s management team is top heavy and relies heavily on a few key executives. The company may suffer if the employees leave.

Economy Risks – YY’s business model relies heavily on top tippers. In a severe economic downturn, YY’s financials might be negatively impacted.

Conclusion

In summary, YY is simply too attractive to ignore. Not only is YY a growing leader in its industry with expanding competitive advantages and a good management team, it is trading at a steep discount on an absolute and relative basis.

Disclosures

The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission.

The author owns shares of YY and may decide to buy or sell without notice.

The author is not receiving compensation for the report. The author has no business relationship with any company whose stock is mentioned in this report.

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2 comments

  1. Where did you get your share outstanding figures? I’m seeing 1.2bn shares outstanding as of 31-Dec-2018. Does that change your thesis at all?

    981,740,848 Class A + 288,182,976 Class B

    Like

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