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Is Momo a Buy?

By Rick Munarriz – Jun 26, 2019 at 1:00PM

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China's social discovery and online dating platform operator has come under fire lately, but it could be too cheap to ignore.

The good news in sizing up Momo (MOMO -5.60%) as a potential investment is that it's cheap. Despite rallying more than 40% so far this year, the stock is trading at less than 12 times this year's projected earnings. The Chinese social video and online dating specialist is growing at a faster clip than its earnings multiple, making this stock appealing to both growth and value investors.

The cherry on top in the valuation argument is that Momo has historically exceeded Wall Street expectations. It has breezed through analyst profit targets every single quarter for more than a year. Put another way, it's probably trading for less than its current multiple of 11.7 times this year's bottom-line estimate.

Before you rush out and place your buy order, know that the "bad news" segment here is longer and more nuanced than the bullish case. You didn't think a piece would start by offering up the good news if there wasn't a pessimist sitting at the low end of the seesaw, did you?

Momo app running on a smartphone.

Image source: Momo.

Bring on the bears

The first part of the cautionary tale when it comes to Momo is that running social networking and dating sites in China isn't easy. The world's most populous nation has some pretty tight clamps when it comes to censoring steamy visuals or politically provocative statements. Then we get to the pitfalls of live video broadcasting, the catalyst for Momo's heady growth over the past couple of years and now up to 72% of its revenue mix.

Even U.S. companies have come under fire for the racy nature of live streaming, a platform that is difficult to police until after the boundaries have been crossed. Momo is no stranger to regulatory oversight. It had to remove its Tantan Tinder-like online dating app from Chinese app stores in late April, a move that keeps current users looking for matches but blocks new users from joining. The once-juicy in-app payments revenue stream for Tantan has also dried up in this regulatory environment. News feed posts for both Tantan and Momo's namesake site were voluntarily suspended in mid-May for a month-long review.

Momo's path won't be smooth. There will always be potholes for it to steer around and roadblocks that will force it to slam on the brakes. Investors seem to think that the road trip is still worth it for now, given the stock's strong 2019 gain despite its springtime setbacks.

Net revenue rose 35% through the first three months of this year, and despite the challenges that have presented themselves during the second quarter, which ends this week, Momo's guidance from last month was still calling for respectable 27% to 30% top-line growth for the period. Analysts see revenue and adjusted earnings rising 28% and 26%, respectively, for all of 2019.

Investors willing to stomach the risks that come with owning a heavily regulated online social platform will be rewarded if things merely stay the course. The stock is too cheap on an earnings basis for it not to pay off as long as it can keep running its business within the tight parameters presented in China. Momo is a very risky buy, but it's a buy nonetheless.

Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool recommends Momo. The Motley Fool has a disclosure policy.

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