Tencent (OTC:TCEHY) recently proposed merging Huya (NYSE:HUYA) and DouYu International (NASDAQ:DOYU), the two largest video game streaming platforms in China. Tencent owns 36.9% of Huya's shares with a 50.9% voting stake, as well as a 38% equity and voting stake in DouYu.

Tencent replaced JOYY (NASDAQ: YY) as Huya's top investor earlier this year after exercising an option to boost its voting stake. That transaction immediately sparked speculation that Tencent would merge Huya and DouYu to dominate the game streaming market.

A young woman plays a video game on a PC.

Image source: Getty Images.

That's why it wasn't surprising when Tencent proposed that Huya and DouYu execute a stock-for-stock merger, in which Huya would exchange a number of newly issued shares for each of DouYu's shares. In a parallel deal, Tencent will buy additional shares of Huya from JOYY and Huya's CEO to boost its equity stake to 51% and its voting stake to 70.4%.

The proposal is non-binding, and DouYu said it would consider the offer, but offered "no assurance" of a deal. Therefore, investors shouldn't assume the two "Twitches of China" will definitely be joining forces, but they should understand the proposed deal and its potential impacts.

What would a merger mean for Huya and DouYu?

Huya's monthly active users (MAUs) grew 17.1% annually to 168.5 million in the second quarter of 2020, while DouYu's MAUs rose 1.5% to 165.3 million. The merger could theoretically create a new platform with nearly 334 million MAUs, but an overlap of users could reduce the final number.

Huya and DouYu both generate most of their revenue from their live-streaming platforms, which allow viewers to buy virtual gifts for their favorite broadcasters. Most of that live content focuses on video games and esports, but some broadcasters also host video chats.

Huya's total number of paid users grew 26.5% annually to 4.9 million last quarter, while DouYu's number of paid users rose 13.4% to 7.6 million. That stable expansion of its paid users enabled both platforms to generate robust revenue growth with stable profits in the second quarter:

Company

Revenue

Growth (YOY)

Net Income (adjusted)

Growth (YOY)

Huya

2.7 billion RMB

34%

351 million RMB

106%

DouYu

2.5 billion RMB

34%

323 million RMB

514%

Q2 2020 numbers. Source: quarterly earnings reports. YOY = year over year.

Analysts expect Huya's revenue and adjusted earnings to rise 34% and 59%, respectively, this year. DouYu's revenue is expected to grow 41% as its adjusted earnings surge 206%.

Investors should always take Wall Street's forecasts with a grain of salt, but Huya and DouYu are clearly benefiting from the simultaneous growth of China's live-streaming and video game markets -- both of which flourished throughout the COVID-19 lockdowns earlier this year.

Merging Huya with DouYu would end the competition between the rivals, eliminate redundancies, and increase the scale of both platforms by merging their users, videos, and servers -- which would boost their margins and profits. It would also provide Tencent, the world's largest game publisher, a seamless platform for promoting its new games and esports events.

Would all three companies benefit from a merger?

The proposed deal would likely benefit Tencent and Huya right away. Creating a market-leading esports streaming platform would complement Tencent's gaming and streaming video businesses, which already overlap with its smaller Penguin Esports streaming platform. That merger could also widen Tencent's moat against Gen Z-oriented challengers like ByteDance.

For Huya, absorbing its only meaningful competitor would boost its revenue and margins, but some dilution could occur with the proposed use of new shares to seal the deal. DouYu would likely reap the same benefits, but it's unclear if Huya's offer -- which has yet to be set -- would satisfy its investors.

This merger would consolidate China's esports streaming market, but we shouldn't assume DouYu's shareholders will approve the deal. It might also face antitrust issues, but the chances seem low since Tencent's other media platforms -- including Tencent Music and Tencent Video -- both have much larger audiences. 

 
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