Description

On 9th Sep 2019, Sohu (majority shareholder) initiated a go-private transaction. Current offer price USD 10 per ADS; purchase price 8.9; 12.3% upside. 69% above the pre-announcement trading price of USD 5.9 per share. All Cash Deal. CYOU will be delisted. I think it is very highly probable that this deal will be completed in 6-9 months.

Sohu is a majority shareholder with 90+% voting control and 68% ownership. Free float: 32% or USD 164m.

Before the privatisation offer on Sep 2019, Changyou was trading ~USD 320m market cap with USD 212m of cash and generating USD 150m of free cash flow (FCF) in 2019.

CYOU is a game company that is famous for Tian Long Ba Bu (TLBB). TLBB is a MMORPG game with 1 PC version and 2 mobile version. The PC game is operating for 12 years now. The online game revenue model is subscription model rather than one-off game purchase. CYOU also has a small cinema advertising business which went bankrupt earlier this year. It should be out of the CYOU by end of 3Q 2019. So CYOU is a pure online game company going forward.

Online game business generated around USD 391m in LTM 2019 and around USD 150m of normalised net profit on a very conservative basis. I think going forward it is likely to generate USD 100m in FY 2019 and maybe decline around 10% a year after that. These long lifecycle games have incredible strength. I won't be surprised if CYOU is able to sustain the online game rev around USD 350m level.

So based on the takeover price of USD 10 per ADS, the market cap is USD 532.5m and EV around USD 320m. So Sohu is paying a 2-3x multiple for the game business.

Note that Chairman / founder Zhang offered to take the company private in May 2017 on a personal level. Would have needed to come up with USD 2.2bn at USD 42.1 offer price. The EV at that time is around USD 1bn and the implied multiple was 5x.

Why didn’t that deal work out the first time?

• I don’t know for sure but my guess would be below
• China game market was in turmoil in 2018 due to game licensing and TLBB started to decline a bit more than expected
• Also because the Chairman is personally offering to buy. He might get some pushback from Sohu minorities where they also indirectly own some of Changyou

Why the deal would pass this time?

• Sohu is the acquiror this time and not Dr Zhang. I think this reflects a change in motivation of privatisation
• Sohu's traditional media business (news portal business like Yahoo) is burning cash and it needed the game business to finance the main business. It is losing around USD 55-60m per quarter. Sohu has USD 100m cash on balance sheet. So to finance the Sohu operations, CYOU had to pay out dividends to transfer the cash from CYOU to Sohu
• CYOU has returned USD 1bn of cash as dividends back to shareholders including Sohu between May 2017 and now. In the process they had to pay a 10% withholding tax to pay dividend.
• So paying a 10% withholding tax to transfer money from one subsidiary to another is quite costly. So by consummating this privatisation deal, Sohu don’t have to pay the 10% withholding tax
• Dr Zhang is very emotionally attached to Sohu's core business. He used to be the equivalent of Jack Ma and Pony Ma at the helm of Sohu 10 years ago
• In 2016, he returned to company after years of doing nothing and vowed to bring Sohu back to the centre of Chinese Internet World
• In short, Sohu needs cash to return the glory of its best days and CYOU is a cash cow

Timing of completion

• Typically these deals take anything from 3 months to 1 year to complete

Catalyst

Deal completion