• Glenn

Is Hello Group really undervalued?

Opdateret: 3. maj

I have often called Hello Group one of the most underrated stocks. In this post I will analyze Hello Group and determine if it is really undervalued or not.

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.

I will not go through a long explanation of what Hello Group does, however you should know that Hello Group is known for their two mobile apps (Momo and Tantan). The Momo app is used for various things such as online dating, social interactions and live streaming, while Tantan is known as the Chinese Tinder. They are market leaders in online dating in China and their moat is a brand moat as their costumers trust the brand. The moat will be further determined once going through the big five numbers later in this analysis but let us first go through the management shortly.

Since I wrote my analysis Momo has changed CEO from Yan Tang to Li Wang. However, Yan Tang is still the executive chairman, which is why I decided to keep some of the original text, as Yan Tang still has much to do with the business. Regarding Li Wang, he has been at Hello Group since 2011 prior to him becoming CEO he was the COO at Hello Group. He has a bachelor degree in management from Beijing University, and prior to joining Hello Group, he was the managing director of Laoluo English Training School. Once he became the CEO he was described by Yan Tang to have a proven leadership track record, and that he believes that Li Wang has the ability to execute their strategic vison and deliver return to shareholders. Regarding Yan Tang, he is the co-founder of Momo and previously worked as an editor-in-chief at Netease. Yan Tang has previously been named one of the most powerful, influential and important business elites under 40 years by Forbes. While I don't know much about Li Wang, I'm comfortable in the leadership of Momo as Yan Tang is still deeply involved with Momo.

We have now determined that Hello Group has a brand moat and we like the management as well. Now let is look into the big five numbers in order to see if Hello Group lives up to our requirements 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 investment capital, also known as ROIC. Usually we want to see ROIC numbers for the last 10 years, however we do not have 10 years of history with Hello Group, which means that we can only go back 7 years and not 10 years. Nevertheless, we will need to do with the numbers we have. Ideally we would like the numbers to be above 10 % and increasing. They are above 10 % in all of the benchmarks, and it is encouraging to see that it is still above 10 % from last year, which was a bad year for Momo due to the pandemic.

The next numbers we will look into are the sales growth rates. We would like the sales growth rate to increase every year. Again we only have 7 years worth of numbers and even though the sales growth rates are great, it is a bit concerning that they are decreasing. However, it could very likely be because if the first numbers mirror their IPO, and the possibilities it gave them just after that. It is a little concerning that the we see a negative number in the last year but it is due to the pandemic, which hurt the business model of Hello Group.

The next numbers are the EPS growth rate and as with the others examples we only have 7 years worth of data. It is slightly concerning that we see a negative number in the 3 year benchmark, while I'm less concerned with the benchmark from last year, as the pandemic hit a business like Hello Group hard. It is something that needs to be monitored though.

Let us look into the equity growth rate now. It is the most important of the four growth rates, and you would like it to be above 10 % in each of the benchmarks. Ideally it should be increasing but these numbers are nothing to worry about, on the contrary you should be happy to see that they actually delivered last year as well.

Finally we look into the cash growth rate. The cash growth rate really took a hot last year due to the pandemic. They have lost some users, which significantly hurt the way they grow their cash. However, according to Momo themselves, they believe they will be able to get users back and grow their cash in a post pandemic world.

To shortly summarize the five numbers from Hello Group. Overall, the numbers are great if you ignore the last year, which was very bad for a company like Hello Group. The most important number will always be the ROIC and Hello Group delivers in all of the benchmarks. In the most important growth rate, which is the equity growth rate, Hello Group delivers as well. There are some minor concerns regarding the cash growth rate and the EPS growth rate, as they did not live up to the requirements in the 3 year benchmark neither. However, Hello Group does have a lot of cash at hand. The sales growth rate declined last year as well, and you would like to see that increase in the post pandemic world. All in all, I'm not concerned regarding Momo based on the five numbers.

Let us just shortly look at debt. In order to determine if a business' debt is reasonable, we want to see that they can pay off its debt within 3 years. We do so by dividing the total long-term debt by current cash flow. I did so with Hello Group and found that they can pay off their debts in 2,21 years. Meaning they do meet our requirements to debt without a problem, and it isn't something we should be concerned about at the moment.

There are some risk with Hello Group though that I will go through here. The first and most obvious risk is the Covid-19 pandemic that we are experiencing at the moment. It does damper the people's inclination and possibilities for social interactions, which was apparent when looking at Hello Group's results in 2020. Another risk is that Tencent launched their dating app called Qingliao last year, which is a competitor to Hello Group. Still Hello Group and Tantan combined are the market leaders in China and they do have a brand moat for the time being, however it is something that needs to be monitored. You might wonder about Tinder but it is blocked in China and can only be accessed by a VPN, meaning it isn't a big threat to Hello Group. Another small concern is that we only have numbers for the last 7 years, ideally we would like to see numbers 10 years back.

Now we have most of the numbers in order to calculate a price for Hello Group. In order to calculate price we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here but we have a current EPS of 1.47, Estimated future EPS growth rate of 12 (It is a bit lower than what most analysist predict but I prefer to be conservative), Estimated future PE 24 (in this case we multiply the growth rate with two, as this is lower than the historical highest P/E) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in my strategy we come up with the sticker price (some call it fair value or intrinsic value) of $27,09, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Hello Group at a Margin of Safety price of $13,54 (or lower obviously).

Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". In order to do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions and in Chinese Yuan. The operating Cash Flow last year was 3.080,89 The Capital Expenditures was 124,14. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I wasn't able to find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 86,90 in our further calculations. The Tax Provision was 755,62. We have 168,52 outstanding shares. Hence, the calculation will be like this: (3.080,89 - 86,90 + 755,62) / 168,52 x 10 = 222, 50 Yuan or $34,26 in TEN CAP price.

The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 10,20 Yuan and a growth rate of 12 %, if you want your purchase back in 8 years, the PAYBACK TIME price is 140,50 Yuan or $21,63.

In the end, I just want to make a small summation. Hello Group has a brand moat and good management. The growth numbers are in general very good, especially if you ignore the last year. There are some risk for Hello Group in the present and in the future though. Luckily, it doesn't seem like the Covid-19 will be here forever, as vaccines are getting rolled out. However, the impact that Covid-19 had on Hello Group's business is significant but it is also an event that wont be here forever. Such an event is the reason that we are able to get Hello Group at the price it is at now. Future risks are especially coming from Tencent, who has launched a competitor to Hello Group. Despite the decrease in the growth the last year and the risks Hello Group is currently facing, I do feel like Momo is a buy under $13,54, as you get it at a 50 % discount to intrinsic value in all of my calculations.

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.

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