Hello Group: A positive turnaround story?
Opdateret: 26. aug.
Hello Group has experienced some difficult years, as it is not easy to operate a dating app during lockdowns. Furthermore, we have seen numerous regulations in China that have put pressure on Chinese stocks. With lockdowns becoming a thing of the past and regulations seemingly on hold, will Hello Group experience a positive turnaround?
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that I own some shares in Hello Group. It currently represents 3.48% of my portfolio. It is a portfolio that anyone can copy if they wish to. If you want to copy my portfolio or just see the stocks that are in the portfolio, you can read more about it here. Despite Hello Group being a significant portion of my portfolio, I will strive to maintain an unbiased analysis. If you want to purchase shares or fractional shares in Hello Group, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.
Hello Group was founded in China in 2011. Hello Group is a prominent player in China's online social networking industry and is primarily recognized for their two mobile apps, Momo and Tantan. Additionally, they own and operate other apps such as Hertz, Soulchill, DuiDui, and Tiete, which cater to niche markets and specific demographics. The Momo app is used for various purposes, including online dating, social interactions, and live streaming. By the end of 2022, it had 94,6 million monthly active users. Tantan is known as the Chinese Tinder, which had 18,4 million monthly active users by the end of 2022. All of Hello Group's apps can be downloaded and used for free, and Hello Group generates their revenue from various services offered on their platforms. Their two largest revenue streams are live video services, accounting for 64% of their revenue, and value-added services, which make up 34% of their revenue. Live video services involve users purchasing and sending virtual items to broadcasters during a live broadcast. Value-added services include virtual gift services and membership subscriptions. The remaining revenue was generated through mobile marketing services, mobile games, and other services. Hello Group is a market leader in online dating in China, and their competitive advantage lies in their strong brand reputation. Customers trust the Hello Group brand, creating a brand moat for the company.
Their CEO is Yan Tang. Yan Tang is the co-founder of Hello Group. He served as CEO from 2011 to 2020 and resumed the position in 2022 after CEO Li Wang resigned for health reasons. He holds a Bachelor of Science degree from Chengdu University of Technology in China. Prior to founding Hello Group, he worked as an editor-in-chief at Netease. Yan Tang has previously been named one of Forbes' most powerful, influential, and important business elites under 40 years old. It is difficult to find much information about Yan Tang, but I generally like founders who are the CEO as they are usually interested in growing the business, and not just their wallets. Thus, I feel comfortable with Yan Tang leading the Hello Group.
I believe that Hello Group has a brand moat, and we also appreciate the management. Now let us examine the numbers to determine if Hello Group meets our criteria for a strong moat. Remember that if you need an explanation of the numbers, please go to "MY STRATEGY" on the website, where I go through which numbers we need in order to analyze the company and calculate a price.
The first number we will look into is the return on invested capital, also known as ROIC. Usually, it is preferable to review ROIC numbers for the past 10 years. However, Hello Group made its IPO in 2014, so we do not have numbers dating back longer than that. Ideally, we want the numbers to be above 10% and increasing. Hello Group has achieved a Return on Invested Capital (ROIC) of more than 10% per year from 2016 to 2020. Hello, Group had a challenging year in 2021 due to the pandemic, which resulted in lockdowns in China affecting the business of Hello Group. It is nice to see that Hello Group managed to achieve a positive Return on Invested Capital (ROIC) in 2022, and hopefully, we will see even higher numbers in 2023 as it seems that lockdowns are becoming a thing of the past in China.
The following numbers represent the sum of the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the percentage growth year over year. Hello Group has historically delivered impressive growth numbers year after year, until 2021. It is pleasing to see that Hello Group has resumed growing their equity in 2022, and I anticipate even stronger growth in 2023.
Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Hello Group has been free cash flow positive since 2015. It is encouraging to see that they managed to deliver a positive free cash flow in both 2021 and 2022, despite these being challenging years for the company. Leveraged free cash flow has been consistently good to acceptable since 2015, and the high free cash flow yield indicates that the stock is trading at an attractive price. We will get back to that later.
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. However, it is not possible to make these calculations on Hello Group because they have no debt. It is obviously very nice to see.
Like with all other investments, there are some risks associated with Hello Group that I will discuss here. One risk is the risk associated with China. Hello Group is a Chinese company, and its operations are primarily in China. It means that they are subject to evolving laws and regulations. We have previously seen that China implemented regulations on live streaming, which resulted in a 10% drop in revenue for Hello Group's live streaming. While another risk in China is the high youth unemployment rate, which could potentially impact Hello Group's business as they primarily target young individuals who may need to allocate their money elsewhere. Geopolitics. Hello Group is listed on the New York Stock Exchange and has been identified as one of the companies that is not complying with the Holding Foreign Companies Accountable Act. It means that Hello Group has three years to comply in order to avoid being delisted. We have observed improvements in the inspection of audits of Chinese companies in Hong Kong by the PCAOB. However, as long as a resolution is not reached, this will remain a risk. Furthermore, if the relationship between the United States and China continues to deteriorate, we may expect to see more regulations in the future. Fewer monthly active users. Hello Group has recently experienced a decline in monthly active users on both Momo and TanTan. The number of monthly active users on Momo was 114,1 million by the end of 2021 and 94,6 million by the end of 2022, while TanTan went from 27,0 million in 2021 to 18,4 million in 2022. Management believes that the decrease in monthly active users is due to social distancing, lockdown measures, and a reduction in marketing efforts. However, it is uncertain whether Hello Group will be able to regain growth in their user base in the long-term.
It isn't all bad, and there is also potential for Hello Group moving forward. TanTan has become profitable. TanTan turned profitable for the first time ever in the first quarter of 2023. Even though it was achieved through cost reductions, there are still positive aspects for TanTan. TanTan experienced a 6% increase in monthly active users during the first quarter, indicating that the decline in users may have been influenced by external factors, as management had previously suggested. Furthermore, management believes that TanTan has now become a sustainable and profitable business, based on its current user base. New apps. Hello Group is developing new apps for different target groups and countries. One app that management has high hopes for is SoulChill, which primarily serves the Middle East and North Africa. SoulChill has, according to management, contributed significant revenue and profit to Hello Group in just two years. Management wants to replicate the SoulChill model in other potential markets to expand their user base and generate more substantial profits. If they succeed in doing so, it could bode well for the future. Attracting users through social attributes and monetizing the traffic through value-added services is a highly profitable business model. The pandemic is over. Hello Group has experienced some challenging years with social distancing and lockdowns, which is not exactly the ideal business environment for a dating app. As mentioned previously, we have observed user growth in TanTan. Management has stated that both monthly active users and user engagement have rebounded rapidly after the Chinese New Year in 2023, and the extent of the recovery was better than the previous year.
Now it is time to calculate the price of Hello Group's shares. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 1,06, which is the one from 2022. The estimated future EPS growth rate is 8%, which is lower than what most analysts predict, but I prefer to be conservative. The estimated future PE is 16, which is calculated by multiplying the growth rate by two, as it is lower than the historical highest P/E. Additionally, we have already set the minimum acceptable return rate at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $9,05. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Hello Group at $4,53 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. Remember that the numbers are in Chinese Yuan. The return should be at least 10% annually, and I calculate it as follows: The Operating Cash Flow last year was 1.635. The capital expenditures were 69. I tried to look through their annual report to see how much of the capital expenditures were used for maintenance. I couldn't find it, but as a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 48 in our further calculations. The tax provision was 534. We have 192,7 outstanding shares. Hence, the calculation will be as follows: (1.635 - 48 + 534) / 192,7 x 10 = 110,07 CNY, which is equivalent to $15,10 in Ten Cap price.
The last calculation is the Payback Time. I also described in "MY STRATEGY". With Hello Group's Free Cash Flow Per Share at $0,86 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is $9,88.
Hello Group has been hit hard during the pandemic. Hence, the management has not been able to execute in the last three years. It seems like social distancing and lockdowns are a thing of the past in China, which should bode well for Hello Group moving forward. However, the recovery we have seen so far has not been able to make up for the loss of users over the last year. Investing in Hello Group comes with a risk related to China, as we have observed Chinese officials implementing regulations that have negatively impacted the business of Hello Group. While it appears that there is currently a pause in these regulations as China aims to stimulate domestic consumption, it is possible that we may witness the implementation of additional regulations in the future. The relationship between China and the United States may also lead to new regulations that will make it harder for Hello Group to access foreign capital. Nonetheless, it is very positive that Hello Group has managed to make TanTan profitable, as it could serve as a catalyst for growth in the future. It is also exciting that Hello Group wants to replicate the success of SoulChill in new markets, which could generate more revenue and reduce Hello Group's dependence on the Chinese market. Personally, I believe that the rewards outweigh the risks when it comes to investing in Hello Group. If I didn't already have a full position, I would consider buying more stocks below the Payback Time price of $9,88. This price offers a 50% discount to the intrinsic value based on two out of three calculations
I also write exclusive posts on Medium. If you want to read my posts, you can join Medium by clicking here. It costs $5 a month, but it will allow you to access all my posts as well as everything else on Medium, which is highly recommendable.
My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how I do it, you can read this post.
I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.
Some of the greatest investors in the world believe in karma, and in order to receive, you will have to give. If you appreciated my analysis and want to get some good karma and show your appreciation, I would kindly ask you to donate a bit to Animals Asia. It is an organization that does a lot of great work such as saving bears from those disgusting bear bile farms. If you have a few bucks to spare and you enjoyed my writing, you would receive lots of good karma, if you would donate a little here. Every contribution matters no matter how little. Thank you.