HUYA and DouYu Combined Is More Than Just A Monopoly

HUYA Inc.’s (NYSE: HUYA) merger with DouYu International Holdings Limited (NASDAQ: DOYU) is the kind of aggressive strategic maneuvering that makes investors go for Chinese ADRs in the first place.

The combination will create a live game streaming behemoth with dominant market share, almost monopolistic if I’m allowed to use that word, with a major strategic advantage over peers, leadership in technology, and better access to top streamers, right set of ingredients to ward off any emerging threats from the likes of Kuaishou.

Financially, the combined company will have some easy to measure cost advantages, but more importantly, the combination will ease on the aggressive bidding for streamers and other resources, instead try to ride and monetize the recent surge in consumer interest.

The next wave of growth in the space will come from live commerce, Cloud gaming, and paid live streaming, things that a common platform with scale, the dominant share of the market, streaming talent, marketing talent, and a balance sheet to support growth will win.

Please note that you can read the granular details of the merger agreement on the company’s website and the same won’t be covered in this note.

Why bother? Live game streaming in China and the power of these two

Source: iResearch China

The live streaming of e-sports and video games has been accepted as a mainstream form of entertainment in China, like the rest of the world. As the chart above shows, the market has achieved scale and growing at 50%+, a rare combination and one that makes the niche a noteworthy technology sub-sector in itself.

Combined DouYu and HUYA Inc. will dominate this second-largest market for live streaming of games in the world with close to 80% market share. Between the two they will have more than 300 million MAUs, one of the largest in the world, even if we discount the number for overlap of users of the two platforms.

First-day arbs, then fundamental research guys, followed by momentum traders

We bought into the correction yesterday. Looking at the price correction in HUYA’s stock, some may conclude that the market didn’t like the deal, on the contrary, the correct conclusion may be that the market failed to acknowledge the combination, leave alone recognizing the power of the combination.

Given the 12% increase in DouYu stock price and an equivalent decline in the price of HUYA, the movement so far seems mainly the arbitrage funds taking a position for the merger. Since Tencent has a significant stake in the two companies and adding Penguin e-sports as well as cash to the mix, it is safe to assume that the merger will go through.

Next to jump on the bandwagon will be the fundamental research-driven investors as they work through the possible synergies from the merger.

Strategic edge

If you think the combination is to gain a monopoly in the Chinese market, you are mistaken.

Yes, near-term, the combination will have a dominant market share and the combined company can gain significantly by cross-selling services, tournaments and using marketing in other creative ways, but an overarching goal of Tencent may be to put a serious fight against emerging threats, be it casual gaming platforms going for live streaming of games or live streaming platforms of other content entering into the gaming market.

One of the major emerging threats is from Kuaishou, a 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.

Bargaining power just shifted

Strategically, the live streaming of games business has a few vulnerabilities, namely

  • Players or streamers  
  • Tech, marketing, and event organizing teams

Maintaining growth is mostly a function of getting popular streamers on your platform, growing content, an increasing number of users, and better monetization of those users.

Streamers

Viewers come to the platform for streamers. Both companies usually have long-term contracts (3-5 years) with top streamers, who attract not just viewers but also mid-tier streamers who grow into top streamers, thus creating a consistent pipeline of talent and viewers.

Top streamers are expensive but create the premium content while middle and low-tier streamers help create the diversified content offering at cheaper rates. The number of streamers with revenue above 10,000 RMB per quarter increased by 40% for DouYu last quarter.

The combined company will have one of the largest and finest collection of top streamers, providing an unmatched edge and high barrier to entry for any new entrant into the live streaming of games business.

Tech, market, and event management

There is more to live streaming than just providing an online platform for streamers and viewers to assemble given the trajectory followed by the industry right now.

Viewers want more than just live streaming of games and companies are facilitating by encouraging more live streaming content from productive streamers, producing and broadcasting of e-sports tournaments.

Between the two, they will be producing and broadcasting more than 100 tournaments each quarter and the combination can avoid overlaps of tournaments and improve occupancy at events. They can organize games between streamers who were exclusive to each platform so far.

These events increase the engagement of an average mobile user who tends to have a higher ‘paying ratio’ as well. The more opportunities viewers have to interact with streamers; the higher is the participation of paying users, besides increasing the payment frequency and participation of gaming advertisers on the platform.

All in all, expect improvement in paying users on the network, payment frequency of those users, advertising revenue, and average revenue per paying user.

Financial edge

HUYA2016201720182019Q1 2020
Revenue Growth 174%113%80%48%
Gross Margins-37%12%16%18%20%
Operating Margins-72%-3%5%6%8%
DouYu     
Revenue Growth 140%94%99%53%
Gross Margins-47%0%4%16%21%
Operating Margins-96%-32%-23%-2%9%

As the chart above shows, even before the announcement, both the companies were on a positive trajectory, be it topline growth, gross margins improvement, or operating profitability. This merger may just accelerate the pace of this improvement. 

Revenue Sharing and Content Costs (% of Rev)2016201720182019Q1 2020
DouYu128.0%90.2%88.7%78.2%74.5%
HUYA73.7%67.4%68.9%69.6%67.4%

One of the biggest cost components for both companies is Revenue Sharing and Content Costs, or simply the cost of streamers. As the chart above shows, this is one cost, which both the companies have found it hardest to bring down. The strength of the combined platform may finally allow savings on this front.

Bandwidth Costs (% of Rev)2016201720182019Q1 2020
DouYu42.6%23.0%15.2%8.5%6.7%
Huya42.4%18.8%14.0%9.6%10.0%

Another major cost component is the bandwidth costs, here again, the combined company can negotiate better prices given the combined entity would have a scale of one of the largest buyers in the country.

DISCLOSURE: We are Long HUYA Inc. stock. Before writing a note, we usually ask (via Twitter and Stocktwits) for things readers would like us to cover in the note, please do share your views for our next note. This is purely an academic exercise for our internal use and you should NOT invest based on this note.

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