Investors Are Swiping Left on the "Tinder of China"

Momo's (MOMO 0.87%) stock recently plunged to a four-year low after the Chinese tech company, which owns two of the country's most popular online dating apps, posted mixed second-quarter earnings.

Its revenue fell 7% year-over-year to 3.87 billion yuan ($547.5 million), missing estimates by $1.3 million and marking its second straight quarter of declining revenue. Its adjusted net income fell 46% to 669.8 million yuan ($94.8 million), or $0.43 per ADS, but still beat expectations by a penny.

Momo expects that pain to continue with a 15%-17% year-over-year drop in revenue in the third quarter, while analysts had anticipated a milder 3% decline. Momo didn't offer any bottom-line guidance, but analysts currently expect a 6% EPS decline in USD terms.

Several analysts downgraded Momo after the dismal report, which indicated the "Tinder of China" was stuck in a rut as bigger Chinese tech companies continued to outperform the market. Let's see why investors are swiping left on this once-hot growth stock, and whether or not it can regain its momentum over the next few quarters.

Image source: Getty Images.

Getting to know Momo

Momo generates most of its revenue from its namesake app, which lets users connect with each other, play social games, and watch live streaming videos. The app is frequently used for online dating, but it generates most of its revenue from the live video ecosystem it launched in 2015.

In early 2018, Momo bought Tantan, another online dating app that closely resembles Match's (MTCH 0.44%) Tinder. It also added live video features to Tantan earlier this year. Momo has also been testing out new apps, including the face-swapping app Zao and the short video app Duiyuan, but these experimental apps don't generate significant revenue yet.

Why did Momo lose its momentum?

Last year, Momo and Tantan were temporarily suspended from China's app stores after being targeted by Chinese censors. However, those bans were eventually lifted, and Momo resumed its streak of double-digit revenue and earnings growth. Unfortunately, its growth hit a brick wall over the past two quarters:

RMB terms. Source: Momo. YOY = Year-over-year. *Non-GAAP.

Momo's growth in total monthly active users (MAUs) on its main app also decelerated significantly over the past year, while its growth in paid users (on both Momo and Tantan) remained sluggish:

Source: Momo. YOY = Year-over-year.

Momo blamed its slowdown in the first quarter on the COVID-19 crisis, which disrupted dating activities with citywide lockdowns and stay-at-home measures. Its cash-strapped live video viewers were also more reluctant to buy virtual gifts for their favorite broadcasters.

In the second quarter, Momo noted its growth was gradually stabilizing as China ended its lockdowns. Its MAUs still fell from a year ago, but grew 3% on a sequential basis -- which suggests the worst is over.

However, its total number of paid users stayed roughly flat from the first quarter as Tantan's declines offset Momo's gains. Momo also warned that spending remained sluggish among its "top of the pyramid" users, and Tantan was "struck harder" by the COVID-19 crisis than Momo.

Momo's adjusted operating margin contracted year-over-year from 35.8% to 26.8% in the second quarter, and that pressure could continue as the company diversifies its platform away from top broadcasters, which earn a bigger cut of its value-added revenue, and top spenders.

Dismissing the competition

Throughout its conference call, Momo's management blamed its declines on macro headwinds and its heavy dependence on its top-tier broadcasters and top-spending users. But over the past year, Chinese tech giant Tencent (TCEHY 2.59%), which already owns the country's top messaging platform WeChat, launched several apps aimed at disrupting Momo's dominance of the online dating market.

When asked about the changing competitive landscape in China's dating market, CFO Jonathan Zhang said Momo didn't "really feel any strong or direct competition that we should be worried about." That dismissive attitude is troubling since Tencent could eventually leverage WeChat's 1.2 billion MAUs to disrupt the online dating market as Momo tries to execute a difficult recovery.

No longer an undervalued growth stock

I once called Momo an undervalued growth stock. The stock still looks cheap at six times forward earnings, but its growth fizzled out in the first half of 2020, and the rest of the year looks even gloomier. Momo recently launched a $300 million buyback plan (equivalent to about 9% of its market cap) to assuage investors, but that's a questionable use of its cash as its core platforms face uphill battles. For now, investors should avoid Momo and stick with bigger and better-diversified tech giants like Tencent and Alibaba.