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Is Momo Still an Undervalued Growth Stock?

By Leo Sun – Jun 1, 2020 at 12:00PM

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The Chinese dating app maker faces an uncertain future.

Momo's (MOMO 0.39%) stock recently dipped after the Chinese tech company posted its first-quarter earnings. Its revenue dipped 3.5% annually to 3.59 billion yuan ($507.6 million), beating estimates by $19.4 million but marking the company's first quarter of declining revenue since its IPO in late 2014.

Momo's adjusted net income fell 19% to 736.3 million yuan ($104 million), or $0.47 per ADS -- which still topped expectations by a nickel. Its numbers cleared analysts' low expectations, but investors weren't impressed, and its stock remains down about 40% for the year.

A man uses a dating app on a smartphone.

Image source: Getty Images.

That steep sell-off reduced Momo's forward P/E to about nine, which indicates the stock could be cheap if its revenue and earnings growth hit double-digit levels again. Can Momo stage a comeback, or will its dating apps struggle to gain new users?

The COVID-19 crisis cools the online dating and video markets

Momo owns two main apps: its namesake app and Tantan. Momo's core app is used for online dating, live streaming, and other social interactions. Tantan, which it acquired two years ago, is essentially a clone of Tinder.

A dating app on a smartphone.

Image source: Getty Images.

Those two apps dominate China's dating market, but they both faced temporary blackouts last year due to censorship issues. Both apps were subsequently restored and gained users throughout 2019, but that growth stalled out in the first quarter.

Momo's monthly active users (on its main app) declined 5% annually to 108 million. Total paying users across both apps fell 9% to 12.8 million. Momo blamed those declines on COVID-19, which reduced online dating activity by locking down users and preventing them from returning to large cities, as well as throttling larger purchases of virtual gifts for its live video broadcasters.

Momo's live video revenue, which accounted for 65% of its top line, fell 13% annually. Its value-added services revenue, which mainly comes from virtual gifts and subscriptions, rose 30% annually and accounted for 33% of its top line, but couldn't offset its waning video revenue.

The remaining sliver of Momo's revenue came from its advertising and gaming businesses, both of which are being downsized.

Declining margins and an uncertain outlook

Momo's adjusted operating margin declined five percentage points annually to 22.3%. Its sales and marketing expenses rose annually, but dipped sequentially during the COVID-19 crisis.

For the second quarter, Momo expects its revenue to rise 5.7% to 8.5% sequentially, which still equals a 6.1% to 8.5% drop from a year earlier. It didn't offer any bottom-line guidance, but warned that it would pay a tax of 220 million yuan ($30.8 million) on its repatriated cash during the quarter, which could significantly dent its earnings growth.

Momo also faces fresh competition in China's online dating market from Tencent (TCEHY -0.17%), which launched several similar dating and live streaming apps over the past year. Tencent might not topple Momo or Tantan with individual apps, but a persistent stream of comparable, well-funded apps could pull away users.

Is Momo still an undervalued growth stock?

Momo's revenue and adjusted earnings rose 27% and 30%, respectively, last year. However, analysts expect its revenue to rise less than 2% this year as its earnings slide 14% -- so it can't be considered a growth stock anymore.

Momo's growth might rebound next year, but competition from Tencent's new dating apps could stunt that recovery. That's why this former growth stock is still trading with a single-digit P/E ratio.

It's probably too early to give up on Momo, but it also isn't a compelling buy for two other reasons: A recent Senate bill threatens to delist U.S.-listed Chinese stocks, and other Chinese tech giants -- like Tencent and Alibaba -- are generating much stronger growth with wider moats. Investors should steer clear of Momo until its live video businesses stabilizes.

Leo Sun owns shares of Tencent Holdings. The Motley Fool owns shares of and recommends Alibaba Group Holding Ltd. and Tencent Holdings. The Motley Fool recommends Momo. The Motley Fool has a disclosure policy.

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