Don’t Make the Mistake of Buying Momo Based on Rumors

Summary

Last week, MOMO appointed Alibaba Cofounder Joseph Tsai, and the stock jumped 31.5%

While there was a buyout proposal last year, but the economic situation in China has changed since then

The stock price of MOMO has gone down 60% since June and besides the rumors, those bearish reasons are still valid

MOMO will publish its Q4 2015 and annual financial results on March 15, we recommend that investors should wait till then to make any investment decisions

Company Overview

Beijing based Momo Inc (NASDAQ:MOMO) is basically a holding company. Momo Inc is best known for operating a dating app called Momo, which was launched in 2011 and currently one of the most popular apps in this category in China. Although Momo Inc promotes the service as a “social network” and says it’s a “fun way to discover, chat and engage with new people,” most user sign up to find dates near their location.

Momo helps users find suitable people based on their location and common interests. Momo is currently available on all major mobile platforms, including Android, iOS devices, and Windows Phones.

Besides the mobile app, the service is also accessible via web and offers a range of related features, functionalities, and tools to help users discover similar minded people.

As of February 28, 2016, Momo Inc has a market capitalization of $2.28 billion and the stock is trading at $11.96.

There is a Potential to Go Private, But Don’t Chase Rumors

The Chinese giant Alibaba Group (NYSE:BABA) has been backing Momo for a long time. They had a small stake in the company even before Momo Inc went public. In 2012, Alibaba Group took a 20% stake in the company for an implied valuation of $100 million.

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Figure 1: Momo Inc Price Jumped 31.58% Since They Appointed Alibaba Cofounder Joseph Tsai to the Board

Last week, Momo Inc appointed Alibaba Group’s co-founder Joseph Tsai as a director to the board, which fueled speculations that he is here to complete a management led buyout. As a result, Momo Inc’s stock price climbed to $12.5 from $9.5, representing a 31.58% increase within a day. As of today, it is trading at $11.96, still representing a 29.16% increase.

Investors should know that just six months after Momo Inc went public, its Chief Executive Officer, Yan Tang, orchestrated a proposal to take the company private at $18.90 per share ((ADR)). Although the buyout offer included funds like Sequoia Capital China Investment Management, the deal did not materialize for a good reason.

First, since the offer came in June 2015, Momo Inc stock price fell to as low as $6.72 per share. When the offer was made, Momo Inc stock was trading near $17, which means the company lost a 60% valuation since the offer was made.

Secondly, the economic climate in China has changed a lot over the last year. Most investors are way more cautious about investing in tech companies compared to last year as the macroeconomic climate is indicating a slowdown.

Momo is Popular, But Unprofitable

Regardless of the popularity of the dating app, which boasts around 180 million users, the company has largely remained unprofitable. Besides posting a temporary positive net income in the middle of 2015, the management had a hard time keeping their heads above the breakeven point.

Yes, we understand the business model. We had our Excite accounts and use to search on Ask.com before the dot-com bubble. And, yes, we are aware that Facebook (NASDAQ:FB) followed a similar “grow at all cost and figure out how to monetize later” business model and so far appeared to doing well.

However, there are hundreds of failed companies for every such success story and investors should not become the victim of survivorship bias while considering which companies to invest in.

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Figure 2: Despite Increasing Revenue, Momo Inc Has Remained Unprofitable

Regardless of increasing its quarterly revenue from $5 million at the start of 2014 to $37.48 million last in Q3 2015, Momo Inc has remained mostly unprofitable. We get that Momo Inc is a growth stage company, and this is very normal to remain unprofitable at this stage.

The point is, there were many reasons why the company lost almost 60% of its value before Joseph Tsai joined the board and the rumors surfaced that Alibaba Group just might take the company private. Those reasons are still valid and investors should not go gaga over just an appointment.

Summit Research Partners’ technology equity research team member Henry Guo told Bloomberg that the joining of Joseph Tsai to the board of Momo Inc is a “may be a sign that the investors are still pursuing the delisting.” But, as an investor, should you make an investment decision based on a “may be?” If you are still wondering, the answer is no.

The Bloomberg correspondent Bonnie Cao also pointed out that “only six out of a record 41 U.S.-listed Chinese companies have completed the process to delist in the U.S.” since the start of 2015.

Conclusion

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Figure 3: Momo Inc Has Ample Liquidity

As an investor taking interest in an early stage growth company, another factor you should consider is the burn rate. As of Q3 2015, Momo Inc had a cash and equivalent of $445.63 million, with a total quarterly expenses of only $39.93 million. The company does not need an immediate influx of cash to maintain liquidity and that’s one of the reasons we believe the original buyout proposal did not materialize in last June.

Since Alibaba Group already has a minority stake Momo Inc, we believe the joining of Joseph Tsai is nothing extraordinary. Alibaba Group is a large diversified company and currently holds a minority share in a lot of companies. Just because its cofounder joined the board of Momo Inc, does not mean he is here to delist the company and make it a private one.

If you like chasing rumors, there might be a momentum play. There are people, who is drawing trend lines and whatnot to justify their decision to go long based on this rumor now. However, if you are a sound investor, who likes to look at the long-term prospects, we believe you should hold on to your guns, at least till March 15, when Momo Inc will release its Q4 2015 and 2015 annual financial results. Make up your mind based on the actual figures then, instead of chasing rumors now.