Description

Intro

We are long shares of Huya, a rapidly growing Chinese live streaming platform focused on gaming and e-sports operating in a duopoly with DouYu (also publicly traded under DOYU). In 2014, Amazon acquired Twitch for nearly $1 billion. At the time of acquisition, Twitch was rumored to have 50 million MAU with minimal revenue. Today, Huya is valued at $2.8 billion with nearly 150 million MAU in the largest gaming market globally with over 680 million gamers that is estimated to grow to ~900 million in 2023. Huya will generate ~$1.2 billion of revenue in 2019, implying a very undemanding revenue multiple of 2.3x (1.7x for 2020). Amazon’s acquisition of Twitch put a spotlight on an emerging trend of video games becoming a spectator sport. In China, where Twitch is banned, the game live streaming industry generated $2 billion of revenue in 2018 and there’s a long runway for growth given the size of the Chinese gaming market. The growing popularity of e-sports should also provide a strong tailwind as Huya is involved in broadcasting some of the world’s most popular tournaments (sometimes exclusively). Huya broadcasted over 110 e-sports tournaments in Q3, drawing more than 560 million viewers. Huya invests heavily in e-sports to draw users to its platform and convert them to active viewers. The average mobile viewer on Huya is extremely engaged, typically spending more than 100 minutes a day consuming content from over 700k streamers.

Shares have been under heavy pressure as the fast-growing sector has drawn the attention from other Chinese internet companies, particularly Kuaishou, the second largest short video platform in China behind TikTok. Kuaishou entered the game live-streaming space in the second half of this year, creating headline pressure for Huya shares. However, Kuaishou has not impacted performance. Huya posted very strong numbers for Q3 with revenue growing 77% y-o-y. Our data vendors indicate that top-line metrics for Q4 also look very strong. So while news around Kuaishou draws attention and investor concern, shares have sold off too much and represent an attractive opportunity.

Source: Company filings.

Leading Platform within Consolidating Industry

Huya and DouYu are the leading platforms for game live streaming and both are positioned to benefit as the industry has been consolidating (note that both are backed by Tencent). Panda, the industry’s third largest player, exited the market earlier this year. Despite this dynamic, investors are concerned about Kuaishou entering the space. At least in the short-term, the concerns are overblown as we’ve seen no impact on Huya’s performance. Also, the game live streaming business model (inherited from Huya’s parent YY) operates within an ecosystem where talent agencies play a critical role as the intermediary between a live streaming platform and streamers/professional gamers. Huya has relationships with over 24,000 talent agencies, 1,500 of which are considered “platinum” that manage over 200k streamers. These relationships are critical as many of these top streamers are professionally managed by these agencies. Our work indicates that as of now, Kuaishou does not have the same level of relationships with these agencies.

Source: Jefferies research.

Top streamers are also locked into contracts that can be as long as 3-5 years. In the live streaming space, top streamers attract the most fans and therefore, most of the live streaming revenue is generated by these popular streamers. Without access to these streamers, it would be difficult for Kuaishou to monetize their userbase at the same level as Huya. 

Overall, Kuaishou’s foray into game live streaming isn’t something to completely dismiss, but for now Huya still holds the advantage as a gaming-centric platform. Kuaishou is also backed by Tencent and it’s hard to imagine that Tencent would want a third player to be in this space. Kuaishou’s latest funding round by Tencent will likely be focused on their core short video platform as they battle against TikTok.

Rapid Growth and Improving Profitability

The Chinese game live streaming market is large and estimated to grow from $2 billion in 2018 to over $5 billion in 2023 as gaming is likely in a very long secular growth period. The market is big enough for both Huya and DouYu to continue to grow for a long time. Top-line metrics for Huya have grown steadily with total MAU, mobile MAU and revenue per user all growing every quarter.

Source: Company filings.

*Paying Ratio = Revenue / paying users (in RMB).

In addition to the strong growth, Huya’s margin profile has been on an upward trend. Gross margins were 12% in 2017, 16% in 2018 and 18% in the latest quarter, driven almost entirely by optimizing bandwidth costs as the business has grown. There is room for gross margins to improve as the industry consolidates towards Huya and DouYu and pricing for top streamers rationalize. The single biggest expense line for Huya is for content costs (paying streamers and for e-sports tournaments). Huya and DouYu compete for the most popular streamers and many of these contracts are structured with upfront one-time bonuses. As competition between the platforms was intense, platforms like Huya spent a lot of money to draw the best streamers to its platform. Often, streamers would renege on their contracts and terminate early to get better economics with a competing platform. However, with the industry basically down to just Huya and DouYu (again both backed by Tencent), there should be more rationale pricing, especially as Tencent is regulating its own users. Tencent released a guide to all of its gaming users earlier this year. One of the standout rules addressed the issue of streamers ending their contracts early. Anecdotally, we’ve also heard that the platforms are structuring the contracts to be more long-term in nature (3-5 years vs. 1-2 years) so that there is less frequency of upfront bonuses. 

Huya has already been benefiting from these industry dynamics and streamer cost margins have been improving but are being masked by the company’s heavy investments in e-sports (expense line within COGS combine streamer costs and investments in e-sports). E-sports is a great funnel for user acquisition; however, the initial monetization of these users is much lower. Over the long-term though, Huya’s strategy to leverage e-sports to grow its user base should be successful and potentially lead to other revenue streams like advertising, which today accounts for a very small % of revenue.

Another key strategy for Huya to improve margins has been to provide non-gaming content. While gaming accounts for 70-80% of Huya’s streaming hours, revenue from non-gaming content now accounts for 40-45% of total revenue. Content from non-gaming (similar to YY Live and Momo) monetizes better and has better ARPU. Huya has also been successful in some niche areas like anime and comics, encroaching on the turf of Bilibili which specializes in that area.  

Putting all this together can create potential for Huya to generate at least 25% gross margins (about 700 bps improvement from today) in the medium term. Over the long-term, the potential could be higher as Huya is exploring other revenue streams like advertising and game publishing. Huya is potentially looking to expand upmarket by publishing games directly and in September, it published Control in SE Asia, HK and Taiwan. Huya also has an international business called Nimo TV which operates in emerging markets like Brazil, Argentina and Southeast Asia. Nimo is expected to reach 20 million MAU by the end of the year. This international business could also provide long-term optionality.

Tencent Option

An overhang on the stock is Tencent’s call option to buy more shares, which becomes active in March. Between March 8, 2020 and March 8, 2021, Tencent has the right to purchase shares to bring their voting power up to 50.1% (currently at 40%). They can do this by either: (1) having Huya issue shares or (2) buying directly from YY. Given how beat up the stock is, Tencent probably wouldn't force Huya to issue shares at a near 52-week low. However, in the event that Tencent decides to have Huya issue more shares, the dilution would be 12% (33.8 new class B shares would bring Tencent voting power to 50.1%). Keep in mind though that Tencent could use a combination of both options so the maximum dilution would be 12%. Even if Tencent decides to take control, the closer alignment of interests would actually benefit Huya.

Source: Company filings and Kerrisdale estimates.

Note: Class A shares entitled to one vote per share and Class B shares entitled to ten votes per share.

Valuation and Conclusion

Huya is among the cheapest Chinese internet stocks on an EV/Revenue vs. revenue growth basis. Huya trades at 1.7x 2020 revenue and 1.4x 2021 revenue, which is very attractive given the growth. While applying an EV/Revenue multiple isn’t the perfect way to value a business, arguing for a 3.0x multiple for Huya is reasonable relative to other Chinese internet stocks. At 3.0x 2020 revenue, Huya would be worth ~$26/share, about 50% higher than today’s levels. Most sell-side analysts model adj. EPS of $0.80 in 2020 and $1.16 in 2021, implying P/E (ex-cash) multiples of 26x for 2020 and 18x for 2021. Given the growth profile and leading market position, these are reasonable multiples in this environment.

Source: CapitalIQ and Kerrisdale estimates.

Overall, the market has overreacted to Kuaishou’s entrance into the market. The ecosystem for live streaming is not easy to replicate and management, benefiting from their long-time experience at YY, continues to make Huya the best platform to watch professional e-sports and for top streamers to broadcast. As sentiment for Chinese tech stocks can change quickly, it could take just one or two quarters of solid fundamentals to allay investor concerns for the stock to work from here.

Catalyst

Strong Q4 earnings

Data releases from vendors

Tencent call option in March