Description

Douyu may be the most hated stock within the most hated sector of the most disfavored market. While much of this disfavor may be justified, it trades at only 28% of net cash.

Douyu is a Chinese gaming livestreaming platform in which Tencent holds a 38% stake. It used to be a duopoly with Huya but in recent years both have been disrupted as Douyin, Kuaishou and Bilibili have expanded into their area and taken share. The overall market growth has also stalled.

The business used to make a small loss but over the past few quarters it has cut a lot of costs, especially in customer acquisition where it eliminated marketing spend that it deemed low ROI. Now it is operating at pretty much breakeven.

Most of Douyu’s cash is untouched from its IPO, denominated in US dollars, held by the Cayman parent entity and available for distribution or any other capital allocation. The Chinese subsidiary operates with a small RMB cash balance. Douyu is earning about $11 million in interest quarterly or around 4.5% annually. That’s a decent return if you’re paying 28 cents on the dollar for it.

Douyu was founded in 2014 by Chen Shaojie who was CEO until he was arrested by Chinese police late last year for investigation related to the pornographic and gambling content on the site. Apparently the authorities in their previous crackdown on illegal content had warned him to stop livestreaming illegal content on his platform and he didn’t. Chen Shaojie holds 17% of shares and voting power. Douyu formed an interim management committee to replace him. The company claims that its operations are unaffected by the investigation.

The large multi-billion-yuan fines handed to Ant Group and Tencent recently should not apply here because these were handled by the financial regulator. Vulgar and obscene content are subject to criminal law and the magnitude of fines stipulated by law, even multiplied by many cases, is typically in the thousands or tens of thousands.

Tencent strategy

Tencent’s core business is games themselves. Douyu and Huya used to be symbiotic for Tencent as they promoted its games, improved engagement and helped Tencent gain market share. Now, in a situation where Tencent’s affiliates are losing out in the game livestreaming market it does not make sense to aggressively fight back (which could be futile and expensive including for outside shareholders), since it needs to maintain a good relationship with all live streaming providers as they are promoting their games. Both Douyu and Huya have focused on efficiency and cost control and are operating at roughly breakeven. It appears that even at a reduced scale these businesses have a profitable core user base that will be enough to keep the lights on.

Relative valuation

Douyu and Huya have always been neck and neck as rivals, with Huya maybe having a slight edge. The stock merger that was attempted in 2020/2021 valued them equally and would have given 50% of the combined company to each of the companies’ shareholder bases. No major differences in performance have arisen since either. In the latest quarter both are operating basically at breakeven with Huya having an advantage only in revenues (1.65bn vs 1.36bn RMB) and MAUs (52m vs 86m). The rate of revenue decline is higher in Huya and Douyu had higher MAU declines. The percentage difference in revenues between the companies hasn’t changed since the merger, however the gap in MAUs has widened due to Douyu’s recent focus on more profitable customers. Huya also has a low valuation at 58% of net cash. Yet Huya’s market cap is now 3 times greater as it trades at $846 million vs Douyu at $278 million.

In May 2023, Tencent bought $220 million worth of supervoting stock in Huya off-market from JOYY at a 76% premium to the market price, almost at book value, paying full price for the net cash. Tencent already had over 70% of voting power, so the control premium itself should not be that high. It is more indicative of the current private market valuation of these businesses - zero for the operations and full value for excess assets.

Tencent tried to merge Douyu and Huya in 2020/2021 in a $5.3 billion all-stock deal but was turned down by the antitrust regulator. Attempting a takeunder of Douyu would put Tencent in an awkward position due to its large controlling stake in Huya and could get in trouble with the antitrust authorities. Tencent’s main goal is to promote its own games but given that Huya/Douyu are no longer gaining new users (both have substantially cut marketing spend) and given up fight against their rivals, becoming sort of Tencent’s live streaming arms, Tencent is likely getting much less value and possibly regretting its involvement. Maybe Tencent would even look to exit one of them (Douyu) but when the stock trades at a fraction of net cash it’s hard to see Tencent being able to sell its stake without in the process somehow benefiting the outside shareholders.

Tencent has been battling Douyin in the courts over copyright and unauthorized live streaming of Tencent games. If the most recent settlement holds and if they are able to develop future partnerships together, it should put Douyu in an even more awkward position. The more awkward the position the more reason for Tencent to find a way out.

Douyu’s board is comprised of 10 directors: 4 independent directors, 2 from Tencent, the founder (who has the right to break ties when he happens to not be detained) and 3 directors likely aligned with the founder. One independent director was ex-partner at Sequoia China. The composition of the board should help minority shareholders get better treatment than they otherwise might at an average Chinese company (or Huya).

Value trap risk

The downside is that Tencent could decide to keep the status quo and keep the capital trapped. However, at the current price it buys us some time to wait a little longer to see what happens. In addition, Douyu has done stock repurchases from time to time.

Stock buyback

Douyu launched a stock buyback program effective January 1st to repurchase up to $20 million of stock during 2024. It should be about 12% of trading volume.

Catalyst

None