Does YY Still Have Room to Run After Its 30% Rally This Year?

YY's (NASDAQ: YY) stock hit an all-time high of $140 last January, but it fell to about $60 by the end of 2018 on concerns about trade tensions, a slowdown in the Chinese economy, and the company's contracting margins.

YY rebounded 30% this year as investors warmed up to certain Chinese stocks again, but the stock remains well below its all-time highs. Let's take a closer look at the company to see if it still has room to run.

How YY makes money

YY's main live video streaming platform, YY Live, hosts entertainment, music, sports, and e-learning videos. Most of its content is generated by users, who earn revenue when viewers purchase virtual gifts or items to unlock premium content.

YY also holds a controlling stake in Huya (NYSE: HUYA), the video game streaming site it spun off in an IPO last year. A significant portion of YY's revenue still comes from Huya, but the unit generates lower-margin revenue than YY Live.

YY also recently acquired Bigo, a Singapore-based company that serves younger users in China, South and Southeast Asia, the Middle East, and America with its BIGO LIVE streaming app and LIKE short video app. The acquisition expands YY's business beyond China and widens its moat against Gen Z challengers like ByteDance's Tik Tok, but Bigo's platforms also generate much lower margins than YY Live.

A small percentage of YY's revenue comes from its legacy online gaming, membership, and advertising businesses. It's phasing out these "other" businesses, which accounted for 5% of its top line last quarter, to focus on the growth of its live streaming businesses.

How fast is YY growing?

Here's how YY's core businesses fared over the past four quarters.

YY expects its revenue to rise 23.4% to 28% annually during the first quarter, but that forecast excludes its acquisition of Bigo. For the full year, analysts expect its revenue to rise 28% on USD terms, but that estimate also doesn't account for the Bigo acquisition. YY hasn't disclosed exactly how much revenue Bigo generates yet.

YY's mobile live streaming monthly active users (MAUs) rose 18% annually to 90.4 million during the fourth quarter. Within that total, its paying live streaming users climbed 37% annually to 8.9 million.

YY's growth in total mobile MAUs decelerated, but its growth in paid users accelerated, fueled by the addition of new services to YY Live, the rising popularity of its top broadcasters, and a partnership with Xiaomi (NASDAQOTH: XIACF) that let it operate the smartphone maker's live streaming platform Xiaomi Live.

This indicates that YY can keep squeezing more revenue out of its existing users to offset an eventual slowdown in its total MAU growth.

But mind the margins

YY's top line growth looks solid, but the expansion of its ecosystem, content costs, revenue-sharing arrangements with content creators, and a higher percentage of revenue from lower-margin units (like Huya) reduced its gross margin from 39.4% to 35.1% between the fourth quarters of 2017 and 2018. Its operating margin, also hampered by its declining gross margin and rising sales and marketing expenses, tumbled from 22.7% to 15.5%.

As a result, YY's non-GAAP net income fell 10% annually as its GAAP net income declined 8%. Analysts expect YY's non-GAAP earnings to fall 8% for both the first quarter and the full year.

Does YY still have room to run?

YY's stock looks cheap at 10 times forward earnings, but that's because investors anticipate negative earnings growth. For now, I'd avoid YY until it gives investors clearer estimates for Bigo and its margins stabilize again.

An attractive alternative to YY is Momo (NASDAQ: MOMO), the online dating and live streaming app which is often called the "Tinder of China". Analysts expect Momo's revenue and earnings to rise 25% and 20%, respectively, this year -- but the stock trades at just 11 times forward earnings.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool recommends Momo. The Motley Fool has a disclosure policy.