Momo Inc. (MOMO) shares declined 10% on May 1, and this was likely triggered by the payment of the special dividend of 76 cents that was completed on April 30. I know, that doesn’t make sense considering the ex-dividend date was April 8, but things can get funny when it comes to investing in stocks. What is not so funny, however, is the fact that Momo is not getting any love from the markets despite the stellar financial performance in the recent past. “Chinese stocks”, they say. I agree, but I don’t intend to leave this country that is expected to become the largest economy in the world by 2050 out of my portfolio because of fraudulent activities by a few companies. Many things are going right for Momo, and when the market does what is expected of it, i.e. rewarding companies that deliver strong financial performance, Momo shares will deliver blockbuster returns to investors.
The thesis is centered on macro-economic tailwinds
The company, at times, has tried to convince investors and users that Momo was not a location-based dating application. Those days came to an end when the company acquired Tantan, the Chinese equivalent of Tinder, in 2018. The global online dating industry has grown in leaps and bounces over the last few years, and when I wrote about Match Group (MTCH) a few months earlier, I pointed out that dating apps have now become the most common way how couples meet. When it comes to China, the industry has years of growth ahead.
According to data from Statista, the online dating industry in China had approximately 60 million users at the end of 2019, with a user penetration of just 4.7%. Total users of dating apps in this East Asian country is expected to reach 83 million by 2024, representing a penetration rate close to 5.8%. The key is to identify how this compares with the western world.
China, as evident, is far behind. We need to find answers to two questions to determine whether Momo will grow in the future.
- Is there reason to believe the penetration of online dating applications will grow in the future?
- If the answer to the first question is “yes”, will Momo benefit to an extent that would improve its earnings meaningfully?
Let’s try to find answers to these two important questions.
China is the most populous country in the world with close to 1.5 billion people. The stellar economic growth of the country in the last couple of decades has led to billion-dollar infrastructure development projects. As a result, the internet penetration rate in China has increased to 59.3% at the end of January. The number of people in China with access to the internet is more than twice the entire population in America, which goes on to show why internet-oriented companies have seen massive success in the last few years.
Source: Internet World Stats
Statista projects internet users in China to grow close to 975 million by 2023. The rise of the middle-income society in the country and the government’s mission to provide internet access to every Chinese resident are the two primary reasons behind this expectation.
To evaluate what this means to Momo and the online dating industry, one should look at the internet penetration rates in countries such as the United States and the United Kingdom.
Source: Internet World Stats
One could imagine how the world-leading internet penetration rates in North America and Europe have helped the online dating industry thrive. In America and many parts of Europe, the majority of the population having access to the internet meant a robust growth opportunity for e-commerce platforms, over-the-top content streaming providers, and social media platforms including dating applications. It’s hard to believe things would be any different in China.
Here’s another interesting stat. Even though a very small percentage of Chinese individuals with access to the internet are using online dating apps, a staggering 78.6% of the internet-using population in the country is shopping online. If an investor had any doubt whether the trends in China are different from the United States, there’s your answer.
As far as I understand (I talked to a group of ten individuals from China who are living and working in Dubai to confirm my thesis), cultural differences are the primary reason keeping Chinese users away from dating apps. However, that too is changing. It has been changing for the last couple of decades as well, and globalization is to thank for this.
Based on this analysis, it seems reasonable to conclude that the penetration of dating apps will increase in the coming years.
Now that the first question has been answered, let’s move on to find an answer to the second question. Will Momo benefit from higher online dating penetration rates?
It was easy to figure out that Momo will be the company leading the charge in China. According to data from South China Morning Post, below are the highest-ranked Chinese dating apps in the Apple App Store.
Tantan and Momo are both owned and operated by Momo Inc. which is a testament to how Chinese users have embraced Momo’s products. That’s the qualitative side. From a quantitative perspective, Momo is the undisputed leader in China. Momo is the dating app with the highest number of users in China, followed by Tantan. From every sense, Momo is dominating the dating industry in this high-growth nation. This market-leading position will help the company benefit from the macro-economic tailwinds that we discussed earlier. Because Momo offers the most popular products, it’s fair to believe that the company is benefiting from a network effect as well. This is a positive development for the company as an economic moat resulting from a network effect will help Momo earn sustainable earnings for a long period of time.
Based on the answers to the two important questions I introduced earlier, Momo can be expected to grow exponentially in the next decade as the Chinese dating industry goes through radical changes that are favorable for online dating apps.
Two steps to mitigate the primary risk of investing in Momo
Momo will deliver attractive returns in the coming years. But, it’s a Chinese company after all, the naysayers say. Investors, however, should not take this any lightly. There’s a developing negative sentiment about shares of Chinese companies trading on American stock exchanges as a result of the spectacular fall of Luckin Coffee (LK). The primary risk of investing in Momo, therefore, is the possibility of shares remaining undervalued even if the company reports eye-popping numbers. Such things have happened in the past. Identifying an undervalued company is not a guarantee of investment returns. Undervalued companies can remain undervalued for longer than our investment time horizon, the same way overvalued companies can remain so for years.
As an investor, I’ve deployed a two-step process to mitigate this risk.
First, I was determined to wait until shares fall deep into the undervalued territory. This way, one could increase the margin of safety. Even when shares were trading in low-thirties, I was convinced Momo was a good buy. Now that she shares suddenly have fallen off a cliff, I believe there’s a sufficient margin of safety to go long on Momo shares now. Shares have been declining since mid-2018, and the GAAP P/E ratio of around 11, in my opinion, does not factor in the massive leeway for growth available for Momo.
In comparison, Match Group shares are trading at a P/E ratio of 40 plus, but the growth profile for the company is not as attractive as for Momo. I’ve been a bull on MTCH for a while, but if you ask me, Momo is a better bet.
Second, my long position on Momo accounts for a very small portion of my investment portfolio. Even though I believe shares are undervalued, I’ve made the decision not to expose my portfolio to equities of international securities by more than 10%. This is a precautionary measure.
These two steps, in my opinion, will help mitigate the risks of investing in Momo.
Takeaway: Momo is a bargain
Momo has everything going right for the company. Everything, because Covid-19 is now behind China, even though it is well and truly wreaking havoc in the United States. Even though revenue growth slowed as a result of unfavorable circumstances in the previous quarter, Momo will come out with a bang in the coming quarters as things return to normalcy in China. The two special dividends declared in 2019 and 2020 are an indication of the commitment by the management to shareholders as well, which is something I like to see in a company. Company executives that try to align a company’s interests with that of shareholders are always a pleasant sight. Momo is undervalued and an expansion of its earnings multiples can be expected by 2021.
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Disclosure: I am/we are long MOMO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.