JOYY Inc. (NASDAQ:YY) reports a significant amount of cash in hand, which makes the company quite undervalued at its current stock price mark. In my opinion, if the company’s artificial intelligence technology continues to evolve, and as user experience gets even better, sales growth will trend north. I do see some risks. However, the downside risk appears quite limited, and the upside potential seems larger.
Founded in 2011, JOYY is a social media company, also offering products like Bigo Live for live streaming, Likee for short-form videos, or Hago for multiplayer social interaction.
In my view, the acquisition made by Baidu (BIDU) a few months ago is one of the main reasons to believe that JOYY knows how to create social media platforms. BIDU, which is one of the largest technological companies in China, acquired a significant part of the JOYY’s business interests in China for $3.6 billion in cash:
On November 16, 2020, we entered into definitive agreements with Baidu, and made certain amendments to the share purchase agreement on February 7, 2021, pursuant to which Baidu will acquire our PRC video-based entertainment live streaming business, or YY Live, including the YY mobile app, YY.com website, and PC YY, among others, for an aggregate purchase price of approximately US$3.6 billion in cash, subject to certain adjustments. The acquisition has been substantially completed, with certain customary matters remaining to be completed in the near future. Source: 20-F
With the previous information in mind, JOYY becomes even more interesting if we read the recent comments made by management about JOYY’s performance. The company does not expect significant business growth from its globalization strategy. According to management, JOYY has already proven its monetization capabilities by reporting 36.5% sales growth. Given this commentary, in my view, it is a sweet time to review JOYY’s business prospects:
In 2021, our business has demonstrated strong resilience despite the macroeconomic uncertainties and challenges posed by the pandemic. As we continued to execute our globalization strategy and strengthen our diverse social entertainment ecosystem, we successfully enhanced our monetization capabilities across multiple product lines, achieving full-year revenue growth of 36.5%. Source: JOYY Reports Fourth Quarter and Full Year 2021 Unaudited Financial Results
Market Estimates And Expectations Of Management Are Beneficial
In the last quarterly report, management announced that it expects Q1 2022 to be close to $601 million, which would imply 2022 sales of $2.4 billion. If we take a look at previous quarterly sales growth, JOYY appears to be growing less rapidly than in the past, but there is still positive sales growth:
For the first quarter of 2022, the Company expects net revenues to be between US$601 million and US$616 million. This guidance excludes the revenue contribution from YY Live in the same period of last year. Source: Press Release
Analysts are optimism about JOYY’s future revenue growth. Market estimates include 10% sales growth in 2022 and 2023, and a median EBITDA margin of 11%. Besides, after negative net income in 2021, shareholders will likely enjoy once again positive net income in 2022 and 2023.
In my view, reviewing the company’s financial projections makes a lot of sense right now. Keep in mind that JOYY is expected to deliver a positive free cash flow margin of 5% and almost 7% in 2022 and 2023, respectively. In sum, analysts are expecting 2023 free cash flow of $219 million.
My Base-Case Scenario Would Include More Video Categories And Content Along With Extensive Use Of Artificial Intelligence
In my view, the most valuable and promising feature of JOYY’s business model is the company’s artificial intelligence technology. If the company continues to improve the way it offers its content to users, user experience will likely increase. As a result, in my opinion, sales growth will trend higher. Besides, with more users, shareholders may enjoy a positive scale, which could have impact on the company’s free cash flow.
Artificial intelligence technology is the backbone of our business success and integrated to all critical aspects of our services and broader business operations: from visual and voice recognition, content recommendation and distribution that optimizes users’ viewing experience, to automated product testing beta and critical corporate decision -making, such as budgeting. As AI improved the accuracy and effectiveness of our content and host recommendations, and optimized our other efforts aimed at improving user experience. Source: 20-F
Under this particular case scenario, I expect that management will continue to offer good video content. In my view, if the number of video categories continues to increase, traffic will likely increase:
We believe that we will be able to capitalize on our large, growing and highly engaged user base around the world by enriching our video content categories, exploring additional monetization opportunities and diversifying our main revenue sources, such as advertising and e-commerce. Source: 20-F
Under my base case scenario, I assumed 57% sales growth in 2022, -23% in 2023, and 10% in 2024. With an EBITDA margin close to 11%, conservative effective tax of 22%, and capital expenditures around $161 million, 2024 free cash flow should stand at $244 million. Note that my assumptions regarding changes in working are close to the figures reported by JOYY in the past.
If we also assume a weighted average cost of capital of 3.69%, with an exit multiple close to 9x, and adding the total amount of cash in hand, the implied share price is $95. Given this figure, in my view, JOYY is currently trading quite undervalued.
In The Worst-Case Scenario, The Fair Value Would Go Close To The Current Market Price
Among the things that could go wrong are changes in regulation, which is a bit likely because JOYY operates in many jurisdictions. In my view, new rules related to user data protection could reduce the total amount of free cash flow that JOY reports:
We face risks and uncertainties to comply with the laws, regulations and rules in various aspects in multiple jurisdictions across the globe including North America, Europe, the Middle East, Southeast Asia, and Eastern Pacific regions, etc. Failure to comply with such applicable laws, regulations and rules may subject our global operations to strict scrutiny by local authorities, which in turn may materially and adversely affect our globalized operations. Source: 20-F
The fact that JOYY has a dual class common share structure is also not ideal. If a sufficient number of researchers note the equity structure, the number of shares acquired by investors may diminish. As a result, the cost of equity may increase leading to a drastic decline in the fair valuation of each share:
Our dual class common share structure with different voting rights will limit your ability to influence corporate matters and could discourage others from pursuing any change of control transactions that holders of our Class A common shares and ADSs may view as beneficial. Source: 20-F
Under a terrible scenario with -25% sales growth in 2023 and -10% in 2024, I obtained 2024 net sales of $2.21 billion and 2024 EBITDA of almost $250 million. Also, with conservative D&A and changes in working capital, 2024 free cash flow would stand at $110 million. Finally, if we use a discount of 15%, which I believe is quite conservative, the implied share price would be between $60 and $65.
If we go even to a more detrimental case and use of -50% sales growth, the decline in the fair price is not that significant. I obtained a valuation of $47 per share. The fact that the company reports a significant amount of cash explains why the result of the DCF model doesn’t decrease significantly as we lower the sales growth.
There is a reason to explain why the company is currently purchasing a significant amount of its own shares. In my view, the Board believes that the company is quite undervalued by the market. I do believe the same:
In November 2021, the Company announced that its board of directors has authorized an additional share repurchase plan under which the Company may repurchase up to US$1 billion of its shares between November 2021 and November 2022. As of December 31, 2021, the Company had repurchased approximately US$235.7 million of its shares. Source: Press Release
Balance Sheet: JOYY Reports A Significant Amount Of Cash In Hand
With $9.1 billion in total assets and $3.4 billion in total liabilities, JOYY’s most remarkable asset is the cash in hand. As of December 31, 2021, management reported $1.83 billion in cash and short-term deposits worth $1.6 billion. In my view, most investors will likely be attracted by the total amount of cash reported by JOYY.
With regards to the liabilities, the company reports convertible bonds worth $924 million, which does not seem worrying given the total amount of cash. With that, I wouldn’t appreciate the potential stock dilution that bondholders could create.
JOYY reports a massive cash in hand standing in the balance sheet, which makes the company quite undervalued. In my view, armed with artificial intelligence and more videos, the company will likely deliver sales growth in the near future. If the number of users continues to increase, I also believe that scale could play a major role, and enhance free cash flow generation. In sum, I see risks coming from regulatory intervention and the company’s dual class structure. With that, the company looks like a buy.