DouYu Has Achieved Critical Mass For Profitable Growth

DouYu International Holdings (Nasdaq: DOYU) is a live streaming service in China, like Twitch owned by Amazon (Nasdaq: AMZN) in the U.S., that has achieved critical mass needed for the stock to attract investor interest.

The live streaming of e-sports and video games has been accepted as a mainstream form of entertainment in China. Two players, DouYu and Huya Inc. (Nasdaq: HUYA), dominate the market, second largest in the world, commanding close 60% market share combined with the industry growing at healthy double-digit rates.

The Street continues to ignore these names thinking that as people resume work there will be a dip in the user base, which may be true to an extent but what that thesis is failing to understand is that the unemployment rate is still high and the consumer media consumption patterns rarely go back. The shift from media to digital streaming, adoption of social media, and music-streaming services are all examples of the same.

The stock, like most Chinese ADRs, also suffered from investor fears related to trade wars and delisting risks. Some of the other risks highlighted by investors recently are irrational competition among existing market participants to attract top streamers and entry of Kuaishou, fast-growing leader in the short video streaming space and one of the hottest startups, in the live streaming of e-sports and video games.

Are Bears missing something? Yes, a lot.

All these fears seem overblown. These overly pessimistic views are failing to see the accelerating growth story that will not just sustain its momentum amid what are usual growing pains of a high-growth business at an early stage but also shift towards leveraging the inherent profitability of the business model.

Ok, if that came out complicated gibberish, we mean,

  • Growth has been steady during the lean phase and may gain pace now
  • Growth from here onwards can be disproportionately more profitable as well

During the first quarter saw sales growing at 53% over last year, which was exceptionally impressive because the first quarter is seasonally slow for live streaming, China was in lockdown due to the Covid-19 outbreak, and Internet cafes were closed that negatively impacted the PC-based MAUs (monthly average users).

Not just the sales, there was improvement all around. Gross margins, net margins, paying users on the platform, average mobile MAUs, etc., all saw double-digit growth rate.

Future growth catalysts: consistent execution above all

What offers confidence in the company’s ability to maintain this growth trajectory is the growing content, increasing number of mobile users, better monetization efforts on the part of the company and focus on quality.

The company is expanding content beyond live streaming, implementing policies to encourage more live streaming content from productive streamers, and producing (40 last quarter alone) as well as broadcasting (50 during last quarter) e-sports tournaments. All these changes at the content level are also increasing engagement of an average mobile user that also have higher ‘paying ratio’.

Increased focus on quality, including making the platform more interactive, is another thing that should bear fruit over the coming quarters. The changes are inviting more paying users on the network, up 26% last quarter, increasing the payment frequency of those users, and encourages more gaming advertisers to the platform. The average revenue per paying user increased 7% last quarter and sales from the advertisement on the network increased by 22%.

Can competition make life miserable? Not so easily.

When Bears talk about competition risks, they refer to,

  • The risk from competing with existing players, mainly Huya Inc.
  • The risk from new entrants entering the space, mainly Kuaishou these days.

Both these risks are exaggerated, at least looking at the valuation of the stock.

Currently, DouYu and Huya are enjoying pseudo duopoly in the live streaming of gaming and e-sports market and investors are worried that rather monetizing the fast-growth of the sector, two might indulge in an unhealthy competition by overpaying streamers to get them on their networks to garner market share.

Revenue Sharing and Content Costs as % of sales2016201720182019Q1 2020
DouYu128.0%90.2%88.7%78.2%74.5%
Huya73.7%67.4%68.9%69.6%67.4%

The fear seems misplaced. As the chart above shows, both companies have been playing it responsibly and trying to bring content costs, the biggest component of costs, down. Interestingly, Tencent Holdings (OTC: TCEHY) has significant holdings in both, 37% in DouYu and 39.4% in Huya, which might also encourage both these companies towards healthy competition.

“In business, I look for economic castles protected by unbreachable ‘moats’”.

Warren Buffett

As for the risk from Kuaishou or other new entrants in the space, the Street seems to be ignoring the moat, the company’s ability to maintain competitive advantages over competitors, around the business model.

The company has long-term contracts (3-5 years) with top streamers, who attract both viewers and mid-tier streamers who grow into top streamers, thus creating a consistent pipeline of talent and viewers.

Top streamers, though expensive, create the premium content while middle and low-tier streamers help create the diversified content offering at cheaper rates. Last quarter, the number of streamers with revenue above 10,000 RMB per quarter increased 40%, providing further confidence to the company’s ability to hold and attract talent.

What about profitability? Yes, it’s finally here

DouYu International Holdings     
      
 2016201720182019Q1 2020
Revenue Growth 140%94%99%53%
As % of Revenue     
Bandwidth Costs43%23%15%8%7%
Revenue Sharing and Content costs128%90%89%78%75%
Other Costs5%4%4%4%3%
Gross Margins-47%0%4%16%21%
      
Operating margins-96%-32%-23%-2%9%

Like many other fast-growth Chinese names, space has been marred by the lack of profitability for the last few years, but as the chart above shows, finally, the costs are getting under contract and the business seems to have achieved the critical mass to deliver profitable fast growth.

This margin improvement has been despite consistent increase revenue sharing fees in absolute terms, increased investments in both eSports-related content rights as well as in-house content production, spending on attracting overseas streamers, and investing in new potential streamers with new game title launches.

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