Hello Group: Undervalued With Expertise In App Development Makes It Attractive

seekingalpha09-24

MOMO is significantly undervalued compared to peers, with a P/E ratio of 5x TTM Non-GAAP earnings and 2x TTM EBITDA, indicating a strong buy opportunity.Hello Group’s expertise in app development and ...

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RgStudio/E+ via Getty Images Hello Group Inc. (NASDAQ:MOMO) reported the interest of Mr. Cook, CEO of Apple. The CEO visited the company in 2024, which could, in my view, bring the attention of new investors in the future. MOMO has a significant amount of expertise in the development of new applications, which, I believe, will most likely enhance subscription generation in the coming years. Taking into account the fact that China is one of the largest markets in the world and the importance of the digital arena in the country, MOMO has many opportunities for business growth and net sales growth. With all this being said, the market did not seem to assess correctly the potential business valuation of MOMO. The company is trading significantly undervalued as compared to peers. The trading multiples are quite reduced. I expect that the stock repurchase program, which the company recently upsized, could enhance the current stock valuation. Even taking into account the risks from the current jurisdiction of incorporation or the operations in China, MOMO looks like a buy from here. Source: StockCharts.com Business Model, And Value Drivers MOMO is a company established in Beijing that has developed terminals internationally to facilitate investment in its business. With less than 30 years of experience, the company has managed to establish itself as one of the main players in the social ecosystem in central China. The company's main product is a mobile application that functions as a social network. In addition, MOMO has Tantan, an application for dating. Although these two applications are the main ones for the group, others have also been developed, such as Hertz, Soulchill, Duidui, and Tietie, with similar functions but more specific demographic characteristics. Due to this form of business, income depends mostly on paid subscribers to company's platforms. The numbers have shown declines in this regard, for MOMO and Tantan. According to the last 20-F, MOMO's paying users went from 8.9 million in Q4 2021 to 7.4 million in Q4 2023. The numbers of paying users of our Momo app were 8.9 million for the fourth quarter of 2021, 7.8 million for the fourth quarter of 2022 and 7.4 million for the fourth quarter of 2023. Source: 20-F Although the company interprets that the drops occurred in part due to a strong cold wave that curtailed social activity, the elimination of spam accounts, and remodeling of the platform, in my view, there are great expectations about these figures for the end of this year. Use of the basic functions of the platforms is free, while paying subscriptions allows users to use premium functions and access other services. According to the last 20-F, at present, revenue is mainly divided into live video functions, including hosting events within the platform, and represents close to 50% share, while the remaining percentage comes from other added services. The company's strategy involves enhancing the positioning of its applications in addition to diversifying the offer for different types of clients. Although, Tantan and MOMO occupy the main places in this offer, and are the ones that attract the largest subscribers. There are also other applications. In all cases, income comes from both subscriptions and the offer of advertising space within these platforms. Taking into account that the Chinese market is one of the largest and most active in terms of population, MOMO seeks to attract foreign investments to develop its infrastructure and deepen its presence in this market. In this regard, I think that the outlook appears quite beneficial. Momo's cash cow business continued to be productive in a healthy community ecosystem. Regarding new endeavors, while strengthening the localization progress, we are more convinced of the revenue growth opportunities in overseas market. Source: Quarterly Press Release In my opinion, one of the main milestones has been the launch of the inSpaze application, exclusive for Apple Vision Pro users. The application has incorporated 12 language models, and allows the design of 3D scenarios, in addition to being connected with audio functions and interaction of Apple. The operation is similar to that of a social network, with the difference that users can easily create their scenarios and avatars, being the company's first immersive reality experience. This development has been a smart company directive, as the Apple Vision Pro enables camera and video functionalities for which there is not yet a large application offering. In my view, the positioning of this product within the top applications of Apple Vision Pro users can be a great driver of the company's growth in the short term. Visit From Mr. Cook, CEO of Apple Hello Group, owner of MOMO and inSpaze, received a visit from Mr. Cook, CEO of Apple, during March of this year. The manager has made positive statements about the functioning of the company in general, and demonstrated interest in future developments of the platform. It is not the first time that Hello Group has remained at the forefront of Apple's developments in China. The development of its main application, MOMO, is delineated in relation to the operation of Apple devices, these users being the main users of the company's application. On the other hand, in my opinion, staying at the forefront of the development of applications with immersive experience functionalities seem to be a great strategy in the medium and long term. There have not yet been companies that have managed to establish themselves within this new digital experience market. In my view, Hello Group has the opportunity to position itself as the main developer in this market among Apple users in China. To close these considerations, in my view, we must remember that TikTok, one of the social networks with the most users in the world, was born from developments by Chinese companies. Although there are proposals to regulate the use of this platform in one of the large markets such as the United States, the precedent in this sense generates great expectations about the adoption, use, and development forecasts of its new platform. A Significant Number Of Employees Are Conducting Research In the last 20-F, the company noted that 864 employees, out of 1382 total employees, work in research and development. I did appreciate this fact. The company appears to be investing a lot of resources in new innovative products, and sales and marketing do not seem that important. I think that promising corporations invest in innovation and dedicate less resources to sales personnel.   Source: 20-F Stock Repurchase Program In my view, it is worth noting that the company acquired a significant number of ADSes from 2023 to 2024. Clearly, directors inside MOMO believe that the stock is quite undervalued at the current price mark. In my opinion, at some point, the stock price may react, driven by the demand that the stock repurchase program brings. In 2024, the company increased the size of its stock repurchase program. Hence, we could expect an increase in the shares acquired in 2024 and 2025. On March 14, 2024, our board of directors approved to amend the share repurchase program to extend the term of the share repurchase program up to June 30, 2026, and upsize the share repurchase program so that we are authorized to, from time to time, acquire up to an aggregate of US$286.1 million worth of our shares in the form of ADSs and/or our ordinary shares in the open market and through privately negotiated transactions, in block trades and/or through other legally permissible means, depending on market conditions and in accordance with applicable rules and regulations. Source: 20-F Risks From The Equity Structure I reviewed the company's list of largest shareholders. There is a large shareholder owning more than 50% of the total amount of voting power. This shareholder could block new transactions that may be beneficial for minority shareholders. In addition, the board of directors may not be independent. It is also worth reminding investors of the fact that MOMO reports both class A shares and class B shares. Holders of class B shares are entitled to ten votes per shares. Owners of class A shares get only one vote per share. In my view, some investors may lower their interest in the company because of these matters. Our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares are entitled to one vote per share, while holders of Class B ordinary shares are entitled to ten votes per share. We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company. None of our major shareholders have different voting rights apart from any Class B ordinary shares that they may hold in our company. Source: 20-F Risks From The Jurisdiction Of Incorporation In the last 20-F, the company noted that the jurisdiction of incorporation is the Cayman Islands. It means that the securities law applicable may be very different from that applied in the United States. We are a holding company registered by way of continuation into the Cayman Islands. Source: 20-F The duties of directors may be not the same as in the United States. Besides, the company reports contractual agreement with entities in China. In sum, the operating subsidiaries are in China. In my view, actions against the company may not be successful. Judges in the United States may not be able to enforce legal actions against directors in the China. Risks From New Regulations In China In my view, investors in the United States may need to take into account that new regulations in China could affect the business model. Among the new regulations recently implemented in China, in my view, changes with respect to data privacy or cybersecurity may change quite a bit the way MOMO operates. If the company needs to invest a significant amount of money to respect new requirements, the operating margins may lower, and the stock valuation could diminish. We face risks associated with recent statements and regulatory actions by mainland China’s government, such as those related to the use of variable interest entities, regulatory approvals on offshore offerings, anti-monopoly regulatory actions, and oversight on cybersecurity and data privacy, which may impact our ability to conduct certain businesses, accept foreign investments or financing, or list on a United States or other overseas exchange. Source: 20-F My Take About The Valuation Of MOMO In my view, the company appears substantially undervalued by the market. Competitors out there trade at higher multiples. The company's PE ratio is also quite cheap. The company current trades at 5x TTM Non-GAAP earnings. The sector median is close to 12x TTM Non-GAAP earnings. Source: Seeking Alpha Platform MOMO also trades at 2x TTM EBITDA, and 3x FWD EBITDA. Other companies in the same sector trade at 10x TTM EBITDA, and 7x FWD EBITDA. Source: Seeking Alpha Platform Considering the EPS expectations for 2025, and 2026, in my view, the company's PE ratio, and EV/EBITDA ratio seem too small. In 2025, analysts expect EPS growth close to 35%. Source: Seeking Alpha Platform I do believe that the fact that the operating subsidiaries are in China may lower the demand for the stock, which could explain the current valuation. With that, the company's ongoing stock repurchases, further increase in net income, EBITDA, free cash flow, and the number of subscribers could push the company's stock price up. In addition, further visibility offered by new well-known CEOs, such as Mr. Cook, CEO de Apple, could bring demand for the stock. Besides, a few years ago, many investors did buy companies trading in the United States and operating in China. It may happen again. Under this beneficial case scenario, I think that MOMO appears well positioned to see an increase in its stock price. We are talking about a company that included an average target price of $45 in 2020. It is currently trading at $6-$7 per share. Source: Seeking Alpha Platform My Opinion Currently trading significantly undervalued as compared to peers, MOMO may receive certain visibility after the visit of Mr. Cook, CEO de Apple. Besides, there are many other stock price catalysts. In my view, the expertise of the company in the development of successful applications like Hertz, Soulchill, Duidui, and Tietie will most likely play a role in the future. The expertise and know-how accumulated could help the company design new platforms.  It is also worth noting that MOMO operates in a massive target market in China. There are many users out there, which, in my view, multiply not only the potential net sales growth, but also the success probability. In addition, the fact that company increased the size of the stock repurchase program in 2024 could indicate that more repurchases are coming. In sum, there are some risks with regard to the jurisdiction where MOMO was incorporated and risks about the operations in China. 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