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Hello Group: A positive turnaround story?

Opdateret: for 1 dag siden

Hello Group has experienced some challenging years, as it is not easy to operate a dating app during lockdowns. Furthermore, we have observed numerous regulations in China that have exerted 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 start by mentioning that at the time of writing this analysis, I do not own any shares in Hello Group. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro, You can find instructions on how to do this here. I don't own any stocks in competitors of Hello Group either. Thus, I have no personal stake in Hello Group. If you want to purchase shares (or fractional shares) of Hello Group, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.

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 its 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 utilized for various purposes, such as online dating, social interactions, and live streaming. By the end of 2023, it had 7,4 million paying users. Tantan is known as the Chinese Tinder, which had 1,4 million paying users by the end of 2023. All of Hello Group's apps can be downloaded and used for free, and the company generates its revenue from various services offered on its platforms. Their two largest revenue streams are live video services, accounting for 50% of their revenue, and value-added services, which make up 47% of their revenue. Live video services entail users buying 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 Momo is a well-established brand with a 12-year history that remains a robust and stable source of revenue. Thus, I believe that Hello Group has a brand moat.

The 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. Yan Tang is renowned for his shareholder-friendly approach in China, as well as for his unwavering commitment to integrity and loyalty towards investors. However, one thing that can be slightly questionable regarding Yan Tang is that he appointed his spouse, Sichuan Zhang, as the Chief Operating Officer (COO). Sichuan Zhang may be the right person for the job, but when appointing one's spouse or other family members to important positions, there is always a risk of nepotism. It is difficult to find much information about Yan Tang. Generally, I prefer founders who also serve as the CEO because they are typically focused on expanding the business rather than just their financial gains. Therefore, I am comfortable with Yan Tang leading the Hello Group.

I believe that Hello Group has a brand moat, and we also value 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 visit "MY STRATEGY" on the website, where I explain the numbers required to analyze the company and calculate a price.

The first number we will investigate is the return on invested capital, also known as ROIC. We require a 10-year history with all figures exceeding 10% for each year. While we do have numbers for the past 10 years, it is worth noting that Hello Group made their initial public offering (IPO) in 2014. Therefore, I wouldn't attach too much significance to the numbers from 2014. Hello Group has achieved a Return on Invested Capital (ROIC) of more than 10% annually 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 the company. It is nice to see that Hello Group managed to achieve a positive Return on Invested Capital (ROIC) above 10% in both 2022 and 2023. Hopefully, the numbers will continue to increase and surpass the figures that Hello Group achieved before the pandemic. Overall, I am encouraged by these numbers.

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 year-over-year percentage growth. Hello Group has historically delivered impressive growth numbers year after year, until 2021, when the company experienced a significant drop in equity due to the pandemic. It is pleasing to see that Hello Group has resumed growing its equity in 2022 and 2023, even though it has not yet reached the pre-pandemic levels.

Finally, we will analyze 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. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Hello Group has been free cash flow positive since 2015, which is encouraging. I believe it is a positive indicator that Hello Group was able to generate positive free cash flow during the lockdown years in 2020, 2021, and 2022. The free cash flow hasn't reached the same levels as before the pandemic, but it is encouraging that free cash flow increased from 2022 to 2023. The levered free cash flow margin hasn't reached the pre-pandemic level yet. However, Hello Group achieved its highest levered free cash flow margin in the past three years in 2023, which gives hope that it will increase in 2024. The free cash flow yield is currently the highest it has been in a decade, indicating that Hello Group stocks are trading at a low valuation. However, we will revisit later in the analysis.

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. After performing the calculation on Hello Group, I found that the company has 1 years of earnings in debt. It is below the three-year threshold. In fact, Hello Group has never had more than three years of earnings in debt since its IPO. Therefore, debt is not a concern for Hello Group.

As with all other investments, there are risks associated with Hello Group that I will discuss here. One risk is having fewer users. The size of Hello Group's user base and the level of user engagement are critical to its success. The user base of our Momo and Tantan apps has decreased every year in the past few years. There is no guarantee that Hello Group's user base will grow in the future. Growing the user base and increasing the overall level of user engagement on their platforms, particularly its live video service, which currently contributes the majority of the revenue, are critical to Hello Group's business. If Hello Group's user growth rate continues to be negative, the company's success will increasingly rely on its capacity to retain current users and improve user engagement on its platforms. If the Momo and Tantan mobile applications cease to be popular social networking tools or if people no longer find Hello Group's services appealing or valuable, the company may struggle to attract users or enhance the engagement of existing users. This could significantly and negatively affect its business and operational performance. Regulations. In recent years, the Chinese government has implemented stricter regulations, rules, and guidelines on various aspects of the internet industry in China. In 2021, China issued the "Guiding Opinions on Strengthening the Administration of Online Live Broadcasts." This regulation mandates online live broadcast platforms to restrict the maximum value of a single virtual gift and the frequency of virtual gifting to remind users when their daily spending reaches a certain threshold. Additionally, platforms are required to implement cooling-off periods and deferred payment options. Imposing any limits on user spending on virtual gifting could potentially have a negative impact on Hello Group's revenues and operational outcomes. Furthermore, new laws, regulations, rules, or guidelines may be adopted in China from time to time to address emerging issues that come to the authorities' attention. Competition. The mobile social and dating industry in China is evolving and competitive, experiencing a consistent influx of new products and market entrants in recent years. In the mobile social and dating industry, costs for consumers to switch between products and apps are generally low. Consumers have shown a willingness to experiment with new methods of connecting with others. As a result, new products, entrants, and business models are likely to continue to emerge. It is possible that a new app could quickly gain popularity, potentially overshadowing existing brands like Momo or Tantan. If Hello Group is unable to compete effectively against its current or future competitors and other apps, products, and services that may emerge, the size and level of engagement of Hello Group's user base may decrease. This could potentially have a significant adverse impact on its business, financial condition, and results of operations.

It isn't all bad, and there are also reasons to invest in Hello Group. Tantan has become profitable. Tantan turned profitable for the first time ever in 2023. Even though it was achieved through cost reductions, there are still positive aspects for Tantan. Management has mentioned that profits for Tantan would have been higher if it weren't for Hello Group making a mistake in ecosystem management, which led to an outbreak of spamming activities in the first part of the year and negatively affected Tantan's user experience and retention. Hopefully, Hello Group won't make the same mistake in 2024, which should help Tantan grow its profits. Management believes that developing products and monetization models for Tantan that are suitable for Asian dating culture will lead to sustainable growth for the platform. Management has mentioned that Tantan is still a very mainstream and important dating product in Asia, especially in Chinese communities. They believe that dating services like Tantan have significant growth potential in Asia and among overseas Chinese communities. New apps. Hello Group is developing new apps for various target groups and countries. These new apps continue to grow, as revenue from them increased by 42% year-over-year. Management has mentioned that they plan to continue enriching the brand portfolio by expanding beyond Momo and Tantan, aiming to build a long-term growth engine. One application that management has high expectations for is SoulChill, which mainly caters to the Middle East and North Africa. Management believes that SoulChill will continue to deliver decent revenue and profit growth in 2024. SoulChill has historically seen growth from audio-based social experiences. However, Hello Group possesses strong capabilities in developing video-based interactive features that could be implemented in SoulChill. Hello Group intends to allocate resources to this endeavor in the current year. Furthermore, management aims 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. Dividends and buybacks. Hello Group doesn't pay regular dividends but has been paying a special dividend since 2019. The dividend payout ratio decreased from 50% to 30% in 2024, but it still offers a high dividend yield at $0,54 per share. The decrease in dividends is due to management's belief that they can utilize their offshore cash reserve for investments overseas. Additionally, management perceives the stock as significantly undervalued since it is trading below its net cash value. Hence, they believe that it's more efficient to buy back shares rather than paying cash dividends. This is why Hello Group has announced an extension of the share repurchase plan. The extension of the plan will enable Hello Group to buy up to $200 million over the next two years to enhance shareholder value.

Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.

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 3,62, which is from the year 2023. I have selected a projected future EPS growth rate of 5%. It is significantly lower than the 39% growth last year, but I don't think that Hello Group can achieve as much cost-cutting this year. Additionally, I have selected a projected future P/E ratio of 10, which is twice the growth rate. This decision is based on Hello Group's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $5,60. 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 a price of $2,80 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 321, and capital expenditures were 81. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 56,7 in our calculations. The tax provision was 89. We have 189,9 outstanding shares. Hence, the calculation will be as follows: (321 – 56,7 + 89) / 189,9 x 10 = $18,60 in Ten Cap price.

The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Hello Group's Free Cash Flow Per Share at $1,26 and a growth rate of 5%, if you want to recoup your investment in 8 years, the Payback Time price is $12,63.

Hello Group has been severely affected by the pandemic. Hence, the management has not been able to execute effectively in the last three years. The pandemic is now a thing of the past in China, and Hello Group has shown improved numbers in 2023. However, it is concerning that Hello Group is losing customers every year. Expanding its user base and increasing the overall level of user engagement on their platforms is critical to Hello Group's business. Therefore, if Hello Group is unable to reverse that trend, it could significantly harm its business. Regulations are also a risk, as we have seen intensified regulations in China in the past few years. It is impossible to know how these regulations will potentially affect the business of Hello Group. Hello Group operates in a highly competitive industry with a continuous influx of new products and market entrants, making it easy for users to switch platforms. Thus, if competition continues to intensify, it could result in more users leaving Hello Group platforms in the future. So far, the Tantan acquisition can be considered a mistake. However, if management successfully transforms Tantan into a consistently profitable business, it could serve as a growth catalyst for Hello Group, particularly if it expands in Asia and among overseas Chinese communities. Hello Group's new apps are growing rapidly, and management expects that overseas revenue will account for a significant portion of Hello Group's total revenue in three years. Especially if Hello Group manages to replicate the SoulChill model in other potential markets. Hello Group doesn't pay a regular dividend, but it has paid dividends in the past 6 years. Although they did cut the payout ratio, the dividend is still high. I personally appreciate that management prioritizes share buybacks when the stock is trading at a low valuation. Nonetheless, I will not be investing in Hello Group at this time because I am concerned that they are consistently losing users year over year. I will need to see Hello Group adding users before considering investing in the company.

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