Can Bilibili Finally Prove the Bears Wrong?

Shares of Bilibili (NASDAQ: BILI) surged 13% on Aug. 28 after the Chinese tech company posted strong second-quarter numbers. Its revenue rose 76% annually to 1.03 billion RMB ($155.1 million), beating estimates.

But on the bottom line, it posted a net loss of 70.3 million RMB ($10.6 million), compared to a loss of 50.4 million RMB a year earlier. On a non-GAAP basis it reported a net loss of 19.5 million RMB ($2.9 million), compared to a loss of 13.5 million RMB a year ago. However, its non-GAAP net loss of 0.07 RMB per share still beat expectations.

Bilibili's post-earnings rally looked impressive, but the stock is only trading 14% above its IPO price of $11.50. Bilibili went public back in March, and its stock briefly soared past $20 in June before giving up most of those gains. Should investors buy Bilibili now?

Understanding Bilibili's business

Bilibili makes most of its money from mobile games. Its top titles include the role-playing game Fate/Grand Order and shooter game Azur Lane. Its mobile gaming revenue rose 61% annually and accounted for 77% of its top line during the quarter.

However, Bilibili is also expanding its live video-streaming, value-added services (comics, music, and other features), and advertising businesses. Revenue from the video streaming and VAS units rose 186% annually and accounted for 12% of the company's sales.

Its advertising revenues surged 132% and accounted for 9% of its top line. The rest of its revenues came from its "other" businesses, which include sales of content-associated and tie-in products via its fledgling e-commerce platform.

Bilibili's long-term goal is to reduce the weight of its gaming business, which faces stiff competition from market leaders like Tencent (NASDAQOTH: TCEHY) and tighter government regulations, while increasing the weight of its video and advertising units.

Earlier this year, CFO Sam Fan told Barron's that the percentage of Bilibili's revenues from games could drop from 83% in 2017 to 50% within three to five years. However, supporting a mobile gaming business while expanding its digital ecosystem is a costly effort. That's why Bilibili's cost of revenues surged 74% annually to 775.9 million RMB ($117 million) last quarter as its operating expenses jumped 88% to 357.6 million RMB ($54 million).

But that spending is yielding results: The company's number of average monthly active users rose 30% annually to 85 million as its mobile active users grew 39% to 71.4 million. Its average monthly paying users nearly tripled to 3 million, while paying users on its mobile games rose 40% to 0.8 million.

Understanding Bilibili's weaknesses

Bilibili's growth figures look impressive, but it faces plenty of competition across the live-streaming, gaming, and advertising markets.

For example, Huya, which owns China's top live game-streaming platform, grew its average overall monthly active users (MAUs) by 25% annually to 91.5 million last quarter. YY, which specializes in live video-streaming, grew its mobile live-streaming MAUs by 21% annually to 80.2 million last quarter.

In video games, Tencent towers above all other Chinese game makers with hit titles like Arena of Valor (also known as Honor of Kings) and QQ Speed. According to App Annie, Tencent publishes six of the top 10 by gross sales iOS games in China. The only publisher that can hold a candle to Tencent is NetEase, which has three games in the top 10.

Bilibili is also outgunned in the online advertising market. Chinese companies generally gravitate toward top-tier advertising platforms like Tencent's WeChat, which reaches over a billion MAUs, or Baidu's search engine, instead of smaller players.

Therefore, Bilibili's year-over-year growth looks impressive now, when its numbers remain low, but they could peak in the near future. That's why it expects third-quarter revenues to remain nearly flat on a sequential basis.

To make matters worse, Bilibili's core growth markets -- video games and live-streaming video -- are both being targeted by Chinese regulators. Regulators recently suspended all new approvals of game licenses, and they repeatedly targeted live video-streaming platforms with new government-issued licenses. Bilibili's mobile app was even temporarily removed from several Chinese app stores between July 26 and Aug. 25 during a "nationwide inspection" of streaming video apps.

Buyer beware...

Bilibili boasts impressive revenue growth, but its growth is decelerating, and its operating expenses could keep rising as it struggles to challenge its bigger rivals. The stock isn't cheap at six times this year's sales, and its bottom line remains deep in the red. Investors should stick with better-established players like Tencent, YY, or Baidu instead of this high-risk stock.

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Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Baidu, NetEase, and Tencent Holdings. The Motley Fool has a disclosure policy.