Is Hello Group really undervalued?
Opdateret: 11. jun.
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.
For full disclosure, I should mention that I own some shares in Hello Group. It is currently 4,19 % of my portfolio. It is a portfolio that everyone can copy if they want to. If you want to copy my portfolio or just see the stocks that is in the portfolio, you can read more about it here. Despite Hello Group being a relatively large part of my portfolio, I will try to keep this analysis unbiased.
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 first wrote my analysis Hello Group 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's 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 can 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 Hello Group as Yan Tang is still deeply involved with Hello Group.
I believe that Hello Group has a brand moat, and we like the management as well. Now let us investigate the numbers 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, you would like to see ROIC numbers for the last 10 years. However, Hello Group made their IPO in 2014, so we do not have numbers dating back longer than that. Ideally, want the numbers to be above 10 % and increasing. Hello Group has a ROIC of more than 10 % a year in the period from 2016 to 2020. I'm not really concerned about the oldest numbers to be below 10 %, and the 2021 number is mainly because of the pandemic, and lockdowns hurts a company like Hello Group hard. Hence, I will give Hello Group a pass on the 2021 number, but I want to see that number improve in 2022.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Hello Group has historically delivered great numbers that has grown year over year. However, like we saw with the ROIC, 2021 has been a hard year for the company. I would like to see an improvement in 2022.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Hello Group has been free cash flow positive ever since 2015. And it is encouraging to see that they managed to deliver a positive free cash flow in 2021 despite it being a hard year for the company.
Let us just shortly look at debt. 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 free cash flow. I did so with Hello Group and found that they can pay off their debts in 3,12 years. Meaning, I feel comfortable with the amount of debt that Hello Group has.
Like with all other investments, there are some risks with Hello Group though that I will go through here. The first and most obvious risk is the Covid-19 pandemic and the lockdowns that follows. China has a zero-tolerance policy when it comes to Covid-19, and we still see lockdowns in China. In their latest earnings call management mentioned that when there are lockdowns, user growth and retention of new users significantly deteriorates. Live streaming regulations. Chinese officials have implemented a series of regulations on live streaming in China in May 2022 that among other things should protect minors. According to management these regulations should result in live streaming revenue should result in live streaming revenue being down around 10 % for the year. Tantan is not profitable in China. Hello Group acquired Tantan in 2018 and it was believed that it would be the next great growth story for them. However, they yet have to make it profitable in China. A dating app will not fare well under a pandemic with lockdowns, but management must make Tantan profitable in China at some point. It should be mentioned that Hello Group managed to make Tantan profitable overseas in the first quarter of 2022. Geopolitics. Hello Group has been identified as not complying with the Holding Foreign Companies accountable act, which means they have 3-year grace period to comply. Hence, Hello Group is dependent on CSRC and SEC/PCAOB coming to an agreement on audit inspections. Furthermore, we have the America Competes Act that will reduce the 3-year grace period to 2 years if it is signed in its current form. Hello Group is currently not listed in the Hong Kong stock exchange, so you won't be able to convert your shares.
It isn't all bad and there are also potential for Hello Group moving forward. Value added services growth. Hello Group is still growing their value added services (VAS) revenue, which helps to partially offset the decline in live streaming revenue. And management is expecting VAS (minus the Tantan business) to grow by double digits in 2022. It is a good thing as VAS has higher margins than live streaming and according to management it is more resilient to economic cycles and difficult external conditions. New apps. Hello Group is developing new apps to new target groups and countries. And while it is still a small part of Hello Group's revenue (RMB 160 million in first quarter 2022), it is growing nicely and revenue on new apps was up by 184 % year over year. Value added services revenue for the new apps were 140 % year over year, while net losses continued to narrow. Hello Group is targeting areas such as MENA area, Latin America and South East Asia with their new social apps. Of Hello Group manages to make some of these profitable, it will add value to the business. Hello Group seems cheap. The book value per share of Hello Group is $8,35, and currently Hello Group is trading well below that price. Hello Group usually pays a special dividend and the last two years it has been $0,64 per share, if they pay the same special dividend next year, it is more than 11 % yield of the current prices. Hello Group has announced $200 million share buyback program over the next 24 months. At the current market cap that is around 17 % of the shares they will buy back.
Now we have most of the numbers to calculate a price for Hello Group. To calculate a 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 use an EPS of 7 (EPS was negative in 2021 but has been above 7 from 2017-2020). Estimated future EPS growth rate of 5 (which is lower than what most analysist predict but I prefer to be conservative), Estimated future PE 10 (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 $28,18, 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 $14,09 (or lower obviously).
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". 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 1.559 The Capital Expenditures was 95. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't 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 67 in our further calculations. The Tax Provision was 822. We have 197 outstanding shares. Hence, the calculation will be like this: (1.559 - 67+ 822) / 197 x 10 = $117 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 $1,17 and a growth rate of 5 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $11,73.
Hello Group has been hit hard during the pandemic. Hence, the management has not been able to execute the last two years. There are still a lot of unknowns regarding Hello Group, as China is still following a zero tolerance Covid-19 policy and is not afraid to enforce lockdowns in major cities. At the same time Hello Group is caught between United States and Chinese regulators regarding their U.S. listing. These risks are the reason that Hello Group trades as such a low price. Personally, I like that they are growing their value added services, which will increase margins and lead to higher profitability. And personally, I will find the valuation very compelling. I wouldn't give too much attention to the TEN CAP price as they seem very high. Even the MARGIN OF SAFETY and PAYBACK TIME prices look a little high. However, being able to buy Hello Group below their book value of $8,35 seems like a good entry price.
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