Description

Overview: HUYA is a classic Ben Graham Net Net name, with market cap of $765m USD, under half of net cash of 10.7b RMB or 1.55B USD. Bear case is fairly obvious -- who (esp. US investors) wants to buy an unprofitable and declining Chinese internet company with no capital return policy? My thesis is that HUYA’s core game streaming business (think Twitch) could be on the verge of stabilizing, and company should be roughly break-even on an operating basis going forward. I am comfortable with the capital allocation risk since Tencent effectively controls the company via 47% of share ownership and 70% voting control, as well as key mgmt. roles occupied by Tencent employees. The company had a merger agreement with a similar sized competitor (DOYU, also controlled by Tencent) blocked by the government in 2021, during the height of CCP crackdown of internet “platform” companies. HUYA actually proposed to issue a $200m dividend associated with the merger, which was since scrapped with the merger blocked. My view is that HUYA is a typical trading sardine like most of its Chinese ADR peers (with more extreme magnitude given size and float) – stock 4x’d from the late October low last year in three months, before correcting 50% last two months. Once market gets comfortable that the company will not burn cash on a grand scale, 0.5x cash could easily go to 0.75-0.8x cash for a decent return. In an upside scenario where Tencent is allowed to consolidate HUYA/DOYU under the current more favorable regulatory environment, stock could be worth multiples of current price. I will keep the write-up brief as I doubt there is much interest given the prevailing sentiment (for good reasons). Happy to answer any questions in Q&A.

Industry Background: In 2014, JOYY (Ticker: YY, written up multiple times on VIC) launched Huya (“Tiger Teeth” in Chinese) to expand into game centric livestreaming. As one of the leading players in China’s gaming streaming market with 84m MAU, HUYA had once seen explosive topline growth, growing revenue from 2.2B RMB in 2017 to 10.9B in 2020, before flatlining to 11.4B in 2021 and declining to 9.2B in 2022, as the company and industry was hit by a perfect storm of regulatory crackdown on gaming and streaming, as well as cut throat competition. In addition to similar sized pure play competitor Douyu, other large video streaming platforms like Bilibili, Kuaishou and Douyin have all become competitors, as they leverage the much larger user base (300-600m MAU). Huge contracts for star broadcasters and irrational bidding for popular e-tournament rights have wrecked operating margins. Indeed, gross margins collapsed from 18-20% to low-mid teens, and operating cashflow went from consistently positive to negative in 2022, culminating in a terrible Q4 2022, in which HUYA lost 700m RMB on an operating basis, due to comically high content costs for League of Legends World 2022. Thankfully the company has vowed to change course and “strive to achieve better ROIs”.

Fundamentals troughing? Q4 was a disaster although well telegraphed and arguably one-off (the contract was signed during the go-go days). For better or worse, the Chinese internet companies as a group have embraced “the year of efficiency” earlier than Zuck, and HUYA is no exception, including cutting sales & marketing expenses by 48% last Q. The streaming industry as a whole has become more disciplined with respect to revenue sharing with broadcasters, and licensing agreements for tournaments, both of which are the biggest cost items. HUYA was able to hold the MAU mostly flattish in 2022, and ARPU should also stabilize/slightly recover in 2023 as they lap the regulatory crackdown last two years. A flood of new game approvals after freezing for almost two years should also act as a tailwind. I am modelling for a small decline in revenue in ’23 and near break-even EBIT, before moderate growth and profits in ’24.

Blocked Merger: Tencent and JOYY owned 74.1% and 25.4% of Class B shares, which constituted 47.0% and 16.1% of total outstanding shares, and 70.1% and 24.0% voting control. HUYA and Douyu hold obvious strategic importance for Tencent as the largest gaming company in China, in terms of distribution and marketing. Tencent has control of most of the top gaming IP assets such as Honor Of Kings and LoL, and naturally prefers to grant licenses to HUYA vs. Kuaishou/BILI/Douyin, all of which are Tencent’s direct competitors. Indeed, Tencent tried to broker a merger between HUYA and DOYU in 2020. The regulatory body blocked the merger in 2021, even though the combined entity still would have far lower MAUs compared to douyin, kuaishou and BILI, and would not represent anything remotely close to a monopoly. The main reason was supposedly the combined entity would have too much control over exclusive gaming contents owned by Tencent. I am cautiously optimistic that the regulatory environment has turned at least temporarily favorable for internet companies. Tencent has always been less aggressive than some of its peers, and has been proactive in voluntarily reducing its clout through spinning off sizable holdings in other internet companies like JD and Meituan. Maybe the government will throw them a bone in a tiny and practically unimportant niche industry.   

Upside/Downside: Valuation here is admittedly more of an art than science. Market cap under half of net cash arguably has priced in a lot of negatives, although I am cognizant that the company traded as low as 0.25x cash late last year, so I have sized it accordingly. I believe current price represents another attractive trading opportunity as 0.5x cash going to 0.7-0.8x would offer almost 50% upside, without ascribing any value to $1.2B+ of revenue or a sticky user base. If the stock drops further, the cash buffer would make it increasingly more attractive in risk/reward. I consider the Tencent ownership/control to be a big plus, as Tencent has a proven track record of treating its shareholders fairly. It is quite likely that the company will institute a dividend policy once the company returns to sustainable profitability.     

Catalyst

Return to break-even