Momo: A Turnaround Is Imminent

Summary

  • I just added Momo to my portfolio.
  • The fundamentals continue to strengthen, while the company is consistently setting new records of new users.
  • The stock is currently offering high double-digits in stock returns from the current share price.

Introduction

A stock will sometimes trade suppressed of its intrinsic value. Oftentimes it’s caused by an overreaction from the market or simply the market not paying attention to the business’s fundamentals. A prudent investor will know that the fundamentals, are what determines a business’s value and not short-term problems. I believe Momo is one of those companies, that is temporarily beaten down by short term uncertainties, while their fundamentals continue to thrive.

The company’s stock price has collapsed ~70% since its peak in 2017. It’s a perfect example of a high-flying stock, that everyone used to praise, to now being forgotten and neglected by the market. Despite its poor stock chart performance, I continue to be bullish on the stock, and recently bought some shares.

Before we take a closer look at their financials, let us first see what the business is doing.

Who is Momo?

Momo is a Chinese company that operates the Momo and Tantan platforms, both of whom are very present in the Chinese dating area. The Momo platform, their eponymous app, has so far been their cash cow, while the recently acquired Tantan platform has been losing money while aggressively expanding.

Fundamentals

Their top line has been growing very consistent and a rather fast pace. Most of the growth has been organic, except the acquisition of Tantan in 2018. While Tantan is still only a minor contributor to the total revenue of the company, management recently said they expect Tantan to overtake Momo and become the growth engine of the company. Seeing how Tantan is currently growing revenue with high double-digits on a yearly basis, it seems like a reasonable prediction.


(Source: FairlyValued.com)

A quick glance at their net income, shows a deviation between revenue and net income growth, suggesting a decline in margins. Momo bought Tantan in 2018, which has been losing money since the acquisition. That is obviously a drag on the company’s margins, but losses have narrowed and Tantan’s growth has been explosive and is expected to continue.


(Source: Macrotrends.net)

The company has also been buying back shares in recent months. Seeing management acknowledging the discount that the company’s shares are trading with and repurchasing some of them is always very encouraging. The company has also in recent years begun paying a dividend, which is very attractive to new shareholders, with the company’s valuation being so low at the moment.

The picture below shows the company’s ordinary outstanding shares on a quarterly basis.


(Source: Yahoo Finance)

Trades with a margin of safety

Momo appears very attractively valued, based on its low p/e of ~11.6, which is much lower than their average p/e of ~18. The company has recently been experiencing a decline in its growth rate, which has spanned over the previous two years. When a growth stock suddenly appears to be slowing down, a premium p/e suddenly becomes hard to justify. Perhaps a more fitting 15 p/e should be attributed, which would be in line with a low/medium growing company. An 11.6 p/e surely seems too low.

Sometimes a business is trading with a low multiplier relative to growth rate, because an excess amount of debt, is carried by the company. A business can comfortably carry 3x their own free cash flow in net debt.

The company, as of their latest quarter, is carrying ~$190m in net debt. Compared to their average Free cash flow of ~$470m, their balance sheet seems well managed and very healthy.


(Source: FastGraphs.com)

The company has demonstrated high earnings growth, but has in recent years been on a slight decline. Analysts are expecting earnings to bounce back, while the company in the meantime has been growing Tantan, expecting it to dethrone their eponymous app Momo in the future. Growth is expected to return and their balance sheet is well managed.

Risks

As all stocks that are trading at a low valuation relative to intrinsic value is having, Momo is also facing some risks.

The company recently acquired Tantan, which management believes could outgrow the Momo app. Tantan has been growing their revenue very fast but has been losing money. The risk is not so much about Tantan becoming profitable or not. It’s about how long it will take. With their main Momo app slowing down, the continuous drag on profitability from Tantan, could become a concern for the market, and continue to further drag down their EPS multiplier.

Momo is a Chinese company, so a potential delisting on the Nasdaq exchange, is something to be aware of. I personally don’t find it too worrying, but a lot of investors seem to do, so it’s just something to be aware of and evaluate yourself.

Final thoughts

Momo is a perfect example of the inefficiency of the stock market. Long term performance is driven by fundamentals, but fear controls the short term. Stocks can go from being overvalued to undervalued and back again, while the business itself remains stable. Momo, once a beloved growth stock, has fallen a long distance fueled by the recent fear of investing in Chinese stocks and a slowdown in earnings growth.

The company has sacrificed short-term profitability, to ensure the company for future growth with Tantan. They are recognizing their low valuation by doing share repurchases, while continuing to strengthen their balance sheet and even paying a dividend. Analysts are expecting earnings to grow again, with the Chinese dating- market opening back up.

Even with only a modest single-digit growth rate going forward, a p/e of 11.6 is very low. I am conservatively expecting the company to return to a standard p/e of 15, which would mean a ~15% stock price gain from current prices.

Author: Daniel Petersen, Seeking Alpha

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