Last week, Line Corporation (LN), creator of a messaging app that’s incredibly popular in Asia, started trading on the NYSE.
On this edition of Industry Focus: Tech, Dylan Lewis and Daniel Sparks give some background about the company and its impressive growth thus far, break down the company’s revenue for the past year, and look at a few of the most pressing concerns that investors should know about before buying into this newly public company.
A full transcript follows the video.
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This podcast was recorded on July 15, 2016.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It’s Friday, July 15, and we're talking about the year's hottest tech IPO. I'm your host, Dylan Lewis, and I'm joined on Skype by Fool.com senior tech specialist Daniel Sparks. Daniel, how's it going?
Daniel Sparks: Good, how are you, Dylan?
Lewis: Doing all right. Yesterday, shares of Line Corporation began trading on the public exchanges. This is an online messaging company. They're trading on the New York Stock Exchange under the symbol LN. Shares are also available on the Tokyo Stock Exchange. The first day of trading treated the company pretty well, right, Daniel?
Sparks: Yeah, shares rose about 30% -- around there -- in the first day of trading. Market cap now is around $8 billion. Like you said, the hottest tech IPO this year. That's one of the reasons it's so well covered. I think you mentioned it's under the symbol LN. It's a Japanese messaging service, similar to WhatsApp Messenger. Huge emphasis on stickers, has messaging voice calls, and they're always trying to add more services for people.
Lewis: I think one of the more interesting stats that I've seen around this IPO, and market news in the past week, is a combination of bullishness from the Line IPO and some of the crazy price movements that we've seen from Nintendo (NTDOY) following the launch, and widespread cultural phenomenon of Pokemon Go. Those two things have pushed market sentiment and the Tokyo Stock Exchange to its best single-week gain since December of 2009. Last time I checked, it was up like 9% this week.
Sparks: Yeah, the timing definitely couldn't have been better for Line to go public.
Lewis: Yeah, I know a lot of people were worried when Twilio (TWLO 0.41%) went public about a month ago, with all the Brexit concerns and things like that, that it was a really poor time to go public. It seems like conditions were pretty great for Line. No complaints there, I'm sure.
Why don't we dive into the business a little bit?
Sparks: Yeah. They started as a messaging service about five years ago. They have around 218 million monthly active users. They're primarily coming from Japan. The service is really popular in Japan, Taiwan, and Thailand. In Indonesia, Line is second to BlackBerry (BB 0.62%)Messaging Service. So Blackberry is good at something. Stickers, like I said, are a huge part of their business model. I think it was the global chief officer pointed to Pokemon Go's success this week as evidence of the value of intellectual properties and characters. They're really big on characters, which is interesting. And you'll see, whenever you see references to Line, all their press material, they always have these cartoon characters showing up. That's somewhat unique, because emojis, in general, are popular right now. But they're really focusing on building out this intellectual property of characters and cartoon characters.
Lewis: Yeah, it seems like it's a very big part of their strategy, and something they anchor to as a differentiator.
Sparks: That's what I would say, is differentiation.
Lewis: You talked about their main markets: Japan, Taiwan, Thailand, and Indonesia. I think those make up about 150 million of the 218 million monthly active users. Japan, I believe, contributes about 70% of revenue for the business. So, they're heavily concentrated in East Asia. They've pulled in roughly $1.2 billion in revenue in the trailing 12 months. Right now, they're posting GAAP losses to the tune of about $55 million. With their current market cap, somewhere around $8 billion, that puts them at just over 7 times trailing sales, just to give you some background there.
You want to dive into how they make money, some of the different segments there?
Sparks: Yeah, I think it's worth returning to what you said, that 70% of the company's revenue comes from Japan. So investors should keep that in mind. 218 million monthly active users might seem small, but when you consider 70% of the revenue comes from Japan, clearly it's a really dominant platform there. Akin to how Facebook (META -0.74%) is popular here in the U.S.
Some of the opportunities here with the business: I think, in the near-term, Line is focusing on expanding its domain. That's interesting. Geographic expansion really isn't their focus. You can see that's been true for them in the past, given their high concentration in just three countries, and the revenue coming from Japan. One of the ways they're expanding is, they're looking into music and video streaming, they recently got into mobile payments, taxi hailing. They're kind of a low-cost mobile carrier in Japan with their Line Out service. So, one of the opportunities is just expanding on their already very engaged user base in their geographic markets, before they actually go outside of those regions.
Lewis: That was one of the reasons they cited as a use of proceeds for the IPO. They said they'd be seeking funds to finance business expansion -- could involve investment, could involve acquisition or some strategic cooperation. One of the other reasons they cited was debt pay down. They mentioned they were going to be using some of the capital from going public to pay down around $400 million in debt. I think a lot of that would be coming due between now and September 2016. Just to give you an idea of what the plans were for the money that they raised.
Sparks: Yeah. One other opportunity worth highlighting is that management believes in this trend -- and it's a trend that hasn't been talked about much, but when you think about it, it could be true. It's hard to tell right now. But Line believes that apps are heading this way where there's going to be more services within the app, that basically, there is beginning to be too many apps, and it's leading to a confusing consumer experience. They believe that’s an opportunity there, too.
Lewis: And you kind of get that sense, when you look at the revenue mix. We looked at a PR release from a couple months ago, and it gave a nice breakdown of how they make money. Top level here: 35% comes in what they categorize as advertising. Another 35% via content; 22% from communication; and 6% from other services. You see that breakdown, and you see, they're fairly well-diversified, and you can see they have their hands in a couple different things.
To give you an idea of what goes into each of those categories, content includes Line Game, Line Music, Line Play, and a whole host of other things. Communication: stickers, what is something that we may or may not agree with being categorized there. Themes: Line Out. Advertising: Line-related ads and portal-related ads.
You see their hands in a bunch of different things, but I'm not so sold on that revenue breakdown that they're providing of 35%-35%-22%. I think it's kind of misleading to have stickers in communication. I think it's really more of something that belongs in content.
Sparks: Right. That highlights two things. There are a lot of areas contributing revenue, which is interesting, and that is what Line wants to do. But yeah, when you lump them into bigger categories, like you said, stickers, and even themes, could be considered a content area. We were talking about this before the show -- maybe sticker and themes are lumped into communication just because it's related to their messaging service. But at the end of the day, if you're trying to evaluate the sustainability of the business model, stickers and themes should be given the same sort of value as content. That is an interesting thing.
Lewis: Just background, in case we've lost any listeners in what a sticker is -- these are basically packages, similar to how you think about an emoji, that users can pay for and use to communicate. So, some of the revenue coming in from there is just people choosing to buy these packages and be able to use them with their friends.
Sparks: An interesting note is, I did hear that some of their characters can cost as much as $6 -- their cartoon characters.
Lewis: That's insane! That is so much money. I don't see it, personally, but I guess that's why I'm not a user. (laughs)
Looking at some of the risks, we've touched on them a little bit before. I think user-based concentration is a big one. 151 million of the 218 million monthly active users are in Japan, Taiwan, Thailand, and Indonesia. Those markets experience growth of 23% year over year. I think that's great. But I just worry about them being able to take this concept and port it over to other countries.
Sparks: Yeah, that is the concern, especially, if they can't grow geographically, it could be a concern because they're basically building their business model into one that's more costly by focusing on expanding their domain within their current regions. As they add more services and become more of a one-stop shop, if there is an app that comes into their geographic region, and starts making inroads on their user base, they're going to be left with this really costly business structure. That's a major risk.
Lewis: That strategy, in a lot of ways, is counter to what we have seen Facebook do. Facebook, for a long time, [the strategy] was build audience, build audience, build audience. Then they've added features. But for them, I think it was much more about global reach first, and building at the platform into these distinct categories, and now focusing on news a little bit more, and live video, and things like that secondary.
Sparks: Yeah, you're exactly right. That really highlights a risk. A lot of times, we're able to look at social networks and say: "How does this relate to what Facebook has done?" Because Facebook, by many counts, has executed far beyond anyone's expectations. They're the standard-setter. It's a little worrisome to see this company trying to really focus on building their domain before focusing on geographic expansion, because it really just hasn't been done at scale yet.
Lewis: And beyond the idea of the concept playing in other markets, and people being willing to pay for stickers, and what they're packaging all together working, you also have a pretty fragmented space in messenging. There are a lot of Goliaths that are already there. It's really tough to break into a market where you have Facebook Messenger, Snapchat, WhatsApp. And beyond that, here in the U.S., I found out from my friend that's a teacher, a lot of her kids use the messenger service that's called Kik, which has a huge U.S. user base. I didn't really know it all that well. But once you get beyond the top-tier companies, there are all these other smaller players there. I just wonder how effectively Line is going to be able to grow their user base outside of East Asia, given how crowded the market seems.
Sparks: Right. I almost wonder if their saying that they're focusing in the near term on current geographic markets could be, almost, a disguise for a massive risk, because, you could look at the fact that they're not in other geographic markets as evidence that these giants are out there. And it's not easy to just jump in and add to the many social messaging apps that people already have. WhatsApp is over 1 billion users. It's huge! Facebook Messenger, 900 million monthly active users. These are huge services. And then you have Kik, and Snapchat. It's not going to be easy to expand geographically. They could be focusing locally just because they have to.
Lewis: That's a great point. But I do think it's going to be tough for them to maintain and grow that $8 billion valuation unless they get out of those markets. You can add on so many services, but really boosting your addressable market and the number of users on a platform is one of the easiest ways to boost your valuation as a company in the social space, right?
Sparks: Right. Another risk, while we're on risks, is the growth is slow. In the last three months, monthly active users total are up 3.3%. Interestingly, even though they only have 218 million monthly active users. Facebook's sequential growth in a three-month period too is up 4%. That's not including all of its other apps -- Messenger, WhatsApp -- which are actually growing faster than Facebook. Facebook is … I can’t remember the exact … Do you remember Facebook's monthly active user base? I think it's ...
Sparks: OK. 1.5 billion. And they're growing faster than Line right now.
Lewis: Yeah, even with a much larger denominator. I think part of the reason that the market was really fascinated by this IPO is, it's the largest one in the tech space so far in 2016. There haven't really been a lot of IPOs. There just hasn't been a ton to be excited about for new companies. But also, this is the first time we're getting a standalone messenger app going public. Facebook Messenger is nested underneath Facebook, Snapchat is currently private. We haven't gotten a glimpse of what the market thinks about this type of business, and I think for the next six months to a year, it's going to be really interesting to watch this company.
Sparks: Yeah. That's a good point. That's one of the biggest things, that it's a messaging app going public. We can look back at WhatsApp's valuation when Facebook purchased it. That was a huge shocker for everyone, when WhatsApp was valued at $22 billion. It just shocked people. What this does for us, is it gives us another comparison to WhatsApp, when you look at it as a valuation per monthly active user. $37 per user is what was paid for Line, and $42 per user was what Facebook paid for WhatsApp. At the time, for some perspective, WhatsApp had 400 million monthly active users when Facebook purchased it, and that was in October 2014. Now they have over 1 billion monthly active users. Just from looking at that, you can tell that WhatsApp is growing faster. But even when Facebook made the purchase of WhatsApp, it was clearly growing faster than Line is now. So it gives investors some comparisons of messaging apps. It makes Facebook's acquisition look a little better. $42 per user for WhatsApp versus $37 for Line finally gives Facebook's valuation a little credence.
Lewis: Yeah, it's nice to be able to level-set a little bit there. Anything else before I let you go, Daniel?
Sparks: Yeah. I think one area worth talking about is Apple (AAPL -1.96%). When they recently announced their upcoming update for iOS, one of the things they started doing is building in all of these services natively into the OS. This brings up a near-term opportunity and a long-term risk. In the near-term, it means services like Line and WhatsApp -- you're going to get a phone call from these services, and it'll actually come through just like a phone call. It's not going to pop up a little notification box you have to click on, and then go into the app and answer the phone call. In the near term, it means all of these companies get more access to Apple's user base. But in the long term, I wonder if it's going to commoditize these messaging apps, and they're all going to seem so similar, and what the value of having a one-stop shop really will be when they're all seamlessly integrated into the user experience. That's another interesting thing to think about.
Lewis: Yeah, that Apple approach takes all of these distinct messaging services and makes them kind of faceless, and puts them in their OS. It makes it a little bit tougher for people to even realize that they might be using them. I think that's an awesome point.
Listeners, that does it for this episode of Industry Focus. If you have any questions, or just want to reach out to say hey, just shoot us an email at [email protected]. You can always tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes, or check out the Fool's family of shows at Fool.com/podcasts. If you're looking for more tech content from the Fool, follow us on Facebook at Motley Fool Tech. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Daniel Sparks, I'm Dylan Lewis. Thanks for listening and Fool on!