4 Signs Momo's High Growth Days are Over

Shares of Momo (NASDAQ: MOMO) have fallen nearly 30% over the past three months, mainly due to a third-quarter earnings report in August that indicated that the company's breakneck growth was slowing down. Nonetheless, shares of the Chinese social networking company remain up 70% for the year.

But looking ahead, I believe that Momo's stock could fall further, since four clear signs indicate that its high-growth days are over.

1. Decelerating revenue growth

Momo's revenue surged 215% annually to $312 million last quarter. That figure seems impressive, until we notice that it's actually Momo's slowest growth rate in five quarters. It also marks a 15% decline from the first quarter.

Analysts expect Momo's slowdown to continue with 116% annual growth in the third quarter and 55% growth in the fourth quarter. They also expect its revenue to grow 135% this year (compared to 313% growth in 2016), and rise just 35% in 2018.

The problem for Momo is that most of its triple-digit gains came from its introduction of a live video streaming platform to complement its core social networking app, which allows users to find and chat with each other based on their locations.

The live streaming business started generating lots of revenue through sales of ads, virtual gifts (which viewers purchase for their favorite broadcasters), or premium subscriptions. Momo splits that revenue, which accounted for 91% of its top line last quarter, with its broadcasters.

The remainder of Momo's revenue comes from mobile games and sales of other mobile ads. Those units are both generating double-digit sales growth, but they're not growing quickly enough to offset the weight of its live streaming business.

2. Stagnant growth in paid users

For Momo to keep growing its live streaming business, it must convert more free viewers to paid ones. Momo's total monthly active users (MAUs) rose 7% sequentially to 91.3 million last quarter, but its number of paying users stayed flat at 4.1 million.

Momo reported that its average revenues per user rose 20% sequentially, which the company attributed to the introduction of more value-added services. That's a positive sign, but it's unclear how much more revenue it can milk from its existing users to offset its slowing growth in paid users.

3. The competition is heating up

Momo isn't the only company that is targeting China's red-hot live streaming market, which grew a whopping 180% to about $3 billion last year, according to iResearch. YY (NASDAQ: YY) -- which established a first-mover's advantage in the space several years ago --- has more paying users (6.3 million last quarter), and it's still growing that figure sequentially at a double-digit rate. That's why YY rallied 50% over the past three months and over 170% for the year.

Other challengers include Weibo, which lets its 376 million MAUs watch live video streams, and hundreds of other streaming apps like Yingke and Xiandanjia.

Earlier this year, Tencent (NASDAQOTH: TCEHY), which owns the country's top messaging app WeChat, pledged to invest nearly $300 million in its Now Live platform. These bigger competitors, along with increased regulatory scrutiny of live streaming apps, could make it tough for smaller players like Momo to keep growing.

4. Soaring operating expenses and waning earnings growth

Lastly, Momo's operating expenses soared 189% annually to $246 million, or 79% of its revenues, last quarter. It attributed those rising costs to higher broadcaster revenue shares on its live video platform, payment channel fees, marketing, and infrastructure expenses.

If Momo wants to stay competitive and retain its broadcasters and viewers, it will likely need to spend even more money over the next few quarters. Momo bulls might think that's fine, since Momo's non-GAAP net income surged 218% to $73.8 million last quarter. But on a sequential basis, Momo's net income still fell 19% -- so it needs to pull off a tough balancing act to protect its bottom line.

The bottom line

Momo might initially seem like an undervalued growth stock, since it trades at just 14 times next year's earnings. But the stock is cheap because investors think that YY's growth has peaked and that it will likely need to spend much more money to stay competitive.

Therefore, Momo might still be a good speculative play on China's booming live streaming market, but investors looking for safer returns should stick with bigger and better-diversified plays instead.

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Leo Sun owns shares of Tencent Holdings. The Motley Fool recommends Momo and Weibo. The Motley Fool has a disclosure policy.