Chinese tech company Bilibili (NASDAQ:BILI) recently agreed to buy a minority stake in Fun-Media, a Japanese company that owns the animation studios Feel, ZEXCS, and Assez Finaud Fabric. These three studios previously produced popular series like This Art Club Has a Problem!, As the Moon, So Beautiful, Diabolik Lovers, The Great Passage, and Ketsuekigata-Kun. The terms of the deal were not disclosed.

Fun-Media president Kawasaki Tomoko stated that the company was "delighted to have Bilibili as our investor and partner," and that the two companies "share the common goal of delivering high-quality animation products to audiences around the world." Tomoko stated that Fun-Media's animated series and films "will further complement Bilibili's broad array of animation content."

Bilibili's logo.

Image source: Bilibili.

Understanding Bilibili's strategy

Bilibili went public at $11.50 in March, and its stock surged to $21 in June before giving up most of its gains on concerns about its widening losses and escalating trade tensions between the US and China.

Many investors were also confused by the way Bilibili branded itself as an "online entertainment platform" for China's Gen Z consumers (born between 1990 and 2000) when most of its revenues derive from licensed mobile games. Last quarter (the second quarter of 2018), Bilibili's mobile gaming revenue rose 61% year-over-year and accounted for 77% of its top line. That growth was mainly attributed to two games: Fate/Grand Order and Azur Lane.

But the mobile gaming market is a crowded once, and two hit games don't constitute solid pillars of growth for a publicly traded company. Therefore, Bilibili is expanding its namesake entertainment portal and app, which serves up streaming video, online comics, and other content for younger users.

As a result, Bilibili's video streaming and VAS (value-added service) revenues surged 186% last quarter against the prior-year period and accounted for 12% of the company's top line. Advertising revenue grew 132% and accounted for 9% of total revenue. The remaining sliver of Bilibili's revenue came from its "other" businesses, which include sales of tie-in products through a tiny e-commerce platform.

The gaming, video streaming and advertising growth engines boosted Bilibili's total revenue by 76% to 1.03 billion RMB ($155.1 million) last quarter. However, heavy investments in the company's ecosystem caused its net loss to widen from 50.4 million RMB to 70.3 million RMB ($10.6 million).

A girl broadcasts a live video on her smartphone.

Image source: Getty Images.

Locking in Gen Z users could be the answer

Bilibili claims that Gen Z users account for 82% of its 85 million monthly active users (MAUs), and that half its users spend an average of 75 minutes per day on its non-gaming platforms. Bilibili also believes that China's 328 million Gen Zers represent "the future of online entertainment" in China.

Last quarter, Bilibili stated that entertainment, lifestyle, gaming, anime, and technology-related content were the five most popular content categories across its platform. The company has also been organizing offline anime-themed events to promote its app. It also pointed out that its total number of original content creators surged 91% versus the second quarter of 2018 to 350 million, and that its number of monthly video submissions soared 131% to 1.16 million.

This tells us two things related to the Fun-Media deal. First, offering more anime series and films could help Bilibili reach more Gen Z users, and increase the amount of time they spend on the platform every day -- which would boost its non-gaming revenues.

Second, Bilibili's focus on user-generated content keeps content costs lower by allowing it to share VAS and ad revenues with top broadcasters instead of paying licensing fees to major studios. By buying a stake in Fun-Media, Bilibili can probably broadcast its content without license fees (or at a discounted rate), and profit from the company's overall growth.

But it still faces a lot of competition

Bilibili's investment in Fun-Media seems like a smart move that could help it pivot away from mobile games, a market which is firmly controlled by Tencent (NASDAQOTH:TCEHY).

However, Bilibili remains a distant underdog compared to streaming video leaders iQiyi (NASDAQ:IQ) and Tencent Video, which have nearly a billion combined MAUs. iQiyi and Tencent Video both offer a wide variety of animated series and films, and both companies have more clout than Bilibili in negotiating favorable content licensing deals.

iQiyi and Tencent Video are both freemium services that display ad-supported videos for free users and offer ad-free content to paid subscribers. However, Tencent and Baidu, which owns a significant stake in iQiyi, are considered the two 800-pound gorillas of the Chinese internet advertising market -- brands are more likely to buy ads on iQiyi and Tencent Video than smaller platforms like Bilibili. Therefore, Bilibili's Fun-Media deal is a step in the right direction, but it probably won't move the needle on its own.

 

Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Baidu and Tencent Holdings. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.