Description

Smart Share Global, aka Energy Monster, is the largest power bank rental business in China. The company pays rent to local services merchant such as restaurant and hairdressers to host the power banks in their store. Smart Share Global call these merchants Point of Interest (POI). Consumers pay an hourly rate of ~ USD 0.2-0.5 per hour depending on the actual location. The difference is captured by the company as profit after deducting operational costs.

The company is trading at USD 254m market cap and has USD 420m of cash. And I think as China’s offline traffic recovers, it can earn about an annualised net income of USD 50m by the end of 2023. This implies an 5x P/E. The company has been buying back shares but the pace of share repurchase has been constrained by the liquidity of the company. I am asking the company to consider paying dividends on top of share buybacks.

1. The demand for powerbank rental is price inelastic and less correlated with macro economy. People use power bank when their phone runs out of battery and given the importance of digital life in urban China (everything is done the phone - ordering food, taxi, grocery, paying for everything in China, booking restaurant). As long as people are out and about, then there is a chance that they run out of battery and hence have a need to use powerbanks. And the need is usually very urgent and hence it is price inelastic

2. This sector experienced rapid growth from 2015 – 2019 but its fortunes turned since COVID as the slowdown of offline traffic has pushed the entire industry deeper into losses. Against this backdrop, the competitive landscape has softened as many competitors exited and/or shrunk their operation. The rent paid to POI also changed from a rent prepayment structure (Energy Monster used to pay 1-2 years rent upfront) to a variable rent structure which should translate into better working capita dynamics as the offline traffic recover in 2023.

3. Furthermore the industry is undergoing a change in business model from direct operations to network partner which makes the business capital light and very cash generative. Under the direct model, Energy Monster would

   1. procure these power banks and carry them on their balance sheet as PP&E

   2. Employs business development (or just sales people) who literally go from merchant to merchant and asking them to install the power bank in their store

   3. Take the risk of paying rent on its P&L

4. But under network partner (NP) model, energy monster would sell the power bank at a 10-20% gross profit to the network partner. And the Energy Monster click a 10% take rate which is of course very high margin. The network partner will be negotiate the rent and do the placement of power bank with the POI. This kind of distributor model is very common in China. From cash flow perspective, Energy Monster basically clicks a small cash for selling the power bank to the NP and then take 10% revenue share. So the unit economics of each power bank become very profitable as compared to direct operation model!

5. From accounting perspective, Energy Monster would still record the power bank on its PP&E while recording as a payable on the liability side. The power bank’s revenue and depreciation would both be record on its P&L but NP’s revenue share will be recorded as sales and marketing cost.

6. As of 1Q 2023, network partners account for 58.8% of total POI and revenue % would be slightly lower than 58.8%. This is up from 30+% only 12 months ago.

7. So why is adding a distribution layer actually improves overall return of this business? Because these network partners are probably local influencers in their cities / districts and they can negotiate significantly lower rent than Energy Monster can ever do. For example, the son/daughter of a hospital’s general manager can place the power banks in the hospital at basically zero rent. But if Energy Monster go and negotiate the rent formally, they would have to pay a fortune and might not even get the contract. For the network partner, they can get their money back probably within 1 year or even shorter. Each power bank can last 3-5 years depending on usage. So the return is very good for the network partner

8. The company has returned to profitability in 1Q 2023 and guiding to over 40% revenue growth YoY in Q2 2023

9. Over the next three years, Energy Monster can still grow by deploying more power banks. I believe it can grow its POI to ~1.3m over the next 3 years which implies high single digit growth. I assume a normalised net margin of 8%. This would imply about USD 70m of earnings by 2025.

Note that reported loss of RMB 711m massively understates the true earning power because 1) the prepaid rent amortisation overstatement is about RMB 353m, 2) the D&A of RMB 421m is also heavily overstated as 50% of the D&A is borne by network partners in reality and 3) the transition to network partner can explain why the business generated ~RMB 300m of free cash flow.

2022 Annual Report has more explanation of network partner accounting if you are interested.

Return:

With some earnings growth and rerating, I can see the stock doubling from here. But I think the probability of a permanent loss of more than 20% is very unlikely just given the level of cash on b/s.

Risks:

My biggest concern is capital allocation. Energy Monster has been experimenting with new initiatives on the side and I am worried that they would throw good money after bad business ideas. I would prefer if they just focus on main business and just return capital to shareholder starting this year.

They have been buying back shares but the liquidity of 50-100k shares per day means that share buyback is not relevant as a scalable means of returning capital to shareholders. I would prefer if they just pay a fat dividend.

Competition is another source of concern. Historically, power bank operators competed on who can give the best terms to POI and that lead to very poor profitability. It could happen that the 10% take rate would decline if they start to compete on who can give the best term to network partners. I think it is unlikely as the industry is sufficiently consolidated after 3 years of COVID.

Privatisation is another risk. Nothing we can do about it.

Catalyst

Earnings normalisation in 2Q 2023, 3Q 2023 and 4Q 2023