While we do not love the idea of investing in China right now, we think many of the equities have become oversold over the past month, presenting a great opportunity to buy low on growing companies. To help mitigate some of the political risk, we have identified a growing, profitable tech company based in China that is barely trading above its current net cash position. In other words- the equity is almost free here, despite positive EBITDA and a huge customer base.
HUYA is the #1 player in video game streaming in China (think Twitch with just over half the users) at about 1/10th the price of Twitch's last valuation via Amazon. We are buying 2024 $10 LEAPS in tranches starting around $1.80, while monitoring the equity's current $6.50ish support level.
Company Overview
HUYA is the leader in the video game streaming platform market in China, enabling broadcasters and viewers to interact during live streaming. The company’s content also covers other entertainment content, such as talent shows, anime, outdoor activities, live chats, online theatre, and other genres. HUYA has essentially become a duopoly in this market in China with competitor DOYU. The parent company of both of these companies, Tencent (OTCPK:TCEHY), actually sought to spur a combination of the two leaders back in the summer of 2021, but the deal was shut down by Chinese regulators. The two stocks have continued to fall even further ever since, with HUYA falling nearly 80% since its February high.
Huya, unlike Twitch and other American tech companies, has monetized its user base through the use of gifting, whereby HUYA takes a percentage of every gift that goes to the streamers from their fans/followers. However, since Tencent took its 50.1% stake in HUYA, the focus has shifted over to the more traditional model of monetizing users through advertising. They were able to double advertising revenue last year, and they expect these sales to rise another 300% by 2023. This will be a major key in unlocking the massive potential of HUYA's 85.1 million monthly active users (MAUs) -- nearly 10x the amount of MAUs on Twitch!
Key Investment Points
We are starting to buy LEAPS on HUYA, as we feel the LEAPS give us a long enough time window to see the recovery in the equity once the broader China equity fears abate. HUYA does not yet pay a dividend, so we are not missing out on income, but we are able to generate more leverage on our position by taking on the time risk inherent in call options. These are not short-term call options, though, as we are willing to pay a premium for a longer call option that will serve as a closer proxy to the underlying equity this far out:
- Strike Price: $10
- Expiration Date: 1/19/2024
- Option Price (1/25/21): $1.80
- Stock Price (1/25/21): $6.86
While we do recognize the points behind the broader selloff in Chinese equities that has taken place over the past year, we strongly feel there are certain equities that have become oversold. In the case of HUYA, the three main China concerns for the company are as follows:
1) There is currently broad-based delisting fear across Chinese ADR shares on US exchanges. While we do not have nearly enough insight into the Chinese government to determine whether this will ever happen (their leaders vehemently deny these delisting rumors), we feel the market has now gone well beyond pricing in a delisting scenario and its likelihood...
"The delisting issue got a lot of attention when DiDi Global (DIDI) delisting news got public, but investors should consider that this is most likely an isolated case. Importantly, Chinese regulators also sounded dovish in a recent statement. The China Securities Regulatory Commission stated that it was respectful of companies' decisions to list their shares where the company desires. It should also be noted that delisting of companies does not at all mean that these companies become worthless. Instead, shares of BABA could likely still be traded through OTC trading, as demand for that would likely be strong. Investors could also exchange their shares for Hongkong-listed shares of Alibaba, which would not be delisted even in an, I believe unlikely, US delisting scenario." - Jonathan Weber on Seeking Alpha
2) Time spent on video games saw a major spike across the world during COVID, and China was no different. However, regulators have gone out of their way in China to attempt to curb time spent gaming amongst children under 18, concerning many investors and leading to mass selling. However, by looking at the user demographics and the live streaming market performance since this rule was instated, it becomes fairly clear that these fears are overblown. In fact, MAUs were up 15% YoY according to HUYA's Q3 earnings.
This graphic shows that less than 30% of HUYA's user base is younger than 25, and even fewer are under 18 and actually exposed to government restrictions on gaming time. This is because the Chinese gaming market has more women and mature users than in the West.
Source: it610.com *figures in graphic are close estimates
3) One of the most attractive aspects of HUYA is it's large cash position that almost equals its market cap. However, western investors are wary of these figures from Chinese companies, as numbers have been misreported by Chinese companies in the past. In the case of HUYA, every dollar in their cash balance can be tied back to it's equity issuances according to SEC filings. They also use PWC as their auditor... Even better, HUYA does not even need to burn this cash to fund business operations, as it is already cash flow positive.
On the cash position front, one must be aware that there is chatter out there that HUYA could turn on its investor base and choose to take the company private at such a low valuation and large cash position. We do not expect this to be allowed, as it sets a really bad precedent for investing in China, but it is still a possibility.
Key Metrics:
EV/EBIT: ~1x
Enterprise value takes into account the massive net cash position of HUYA and highlights how low the multiple has gotten due to overselling based on broad fears that have not been realized to this point
With the aid of Tencent, HUYA was able to double advertising revenue last year, and they expect these advertising sales to rise another 300% by 2023
Going forward, the user base of game-centric live streaming in China is forecasted to grow with a CAGR of 9.4%
This will help drive further increases in MAUs despite the policy headwinds from Chinese regulators
The stock has fallen ~80% from its February high and even further from 2018 levels as the market has been indiscriminate in its sales of Chinese companies over the past year, but the risks for HUYA do not match up with this price drop.
It finally appears HUYA is meeting some resistance recently around the $6.50 area, but we are buying LEAPS in blocks over time as we wait for a solid uptrend
Huya recorded $1.72 billion in Cash and Cash Equivalents against total liabilities of $0.43 billion in Q3 2021, so with a market cap of ~$1.55 billion, the company only trades at ~$250 million above cash, despite positive and growing cash flows
My Favorite Links
From folks much smarter than I....
- Bullish article from an ex-poker player who is using options to generate returns amidst the volatility in the stock
- Ties out the cash position on the balance sheet to each equity issuance to help assuage any fears around misreporting of the current massive cash position
- Uses the CAPE method to value HUYA and gets to a fair value of $14.87, representing over 100% upside
- Bullish article from an American living in China, so he has a good perspective on the gaming culture in China and is familiar with the product
- Highlights the gaming culture in China and how massive the opportunity is
- Analyzes user feedback on HUYA vs DOYU and finds that most people view HUYA as the better platform (DOYU is very unprofitable and pays a lot to acquire users/streamers)
- I highly recommend reading through the last earnings transcript (don't worry, it's in English), as it does a good job of highlighting all of the different initiatives taking place at HUYA to help drive retention and growth
- Questions on margins highlight that funds are focused on the dip in gross margin to ~15%, when the trend is closer to low 20s. They explain that this was due to an increase in spend on new content and acquiring new streamers for their platform
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