Kuaishou: The TikTok contender

History

Kuaishou initially started as “GIF Kuaishou” back in 2011. It was a mobile app created purely to share GIF pictures. In 2013, it transformed into a short-video and social media platform for users to share their everyday activities.

According to Technode, the number of daily user surpassed 100 million in 2013. (Techcrunch, 2017) For long, it was Asia’s highest valued Tech company until other tech giants like Tencent and Alibaba rose to the stage.

In 2017, the company got into a bidding war with ByteDance (Tik Tok/Douyin) over Musical.ly, the Chinese social media app which mainly focused on overseas markets. Eventually, ByteDance closed the deal and later merged the app with its existing app, Tik Tok.

In February 2021, Kuaishou set for an IPO in Hong Kong. The company sold shares at the maximum of its price range, in a deal that ranked as the world’s biggest internet IPO since Uber.  On its first trading day, shares jumped 161% to HK $300 after reaching a high of HK $345. Currently, the stock is trading in the HK $256 region.

Despite its impressive user growth over the years, the company isn’t profitable. It added up close to 10 bln USD in losses in the first 6 months of 2020. This is an incredible amount, which we cover further in the quantitative segment. Following its listing, it was added to the Hang Seng Index, the main index for Hong Kong equity. Today, the company is the 10^th  largest stock listed on the Hong Kong exchange. Let’s look at how the ownership structure is set up.

Ownership

According to its preliminary financial filing in November 2020, the ownership structure at that date was set as follows:

• Tencent owned just under 21.6% of Kuaishou. The tech giant is a key strategic investor since it owns WeChat and is one of the biggest players in the mobile gaming space.
• 5Y Capital owned 16.7% of outstanding shares.
• DCM owned 9.2% of outstanding shares.
• DST Global owned 6.4% of outstanding shares.

Other investors include Capital croup, Invesco and Fidelity. Note that the stock is currently trading around 15% below its IPO price.

Key Metrics

What we think is fascinating about this platform are 2 main things, the first one being the way in which it is able to keep customers’ attention – the so-called “eyeballs” – and the second one being the speed in which it is able to grow its number of daily users.

The average daily user on Kuaishou spends over 87 minutes (!) on the platform per day. For Instagram, this number is around 29 minutes (Business of Apps, 2021). The number of daily users on Kuaishou 257.7 million, up around 65% year-on-year.

It’s worth noting that it is still not as popular as the Chinese (original) Tik Tok – Douyin – which reported 600 million daily users in August 2020 (Protocol, 2021). This number is up from 320 million in July 2019, close to doubling its number of daily active users over the course of a year. Note that both Tik Tok and Douyin fall under the same company, ByteDance.

Let’s look at some of the key metrics below.

The Industry

Below, we show a couple of graphs to get an idea of the short-video space in China

According to the China Internet Network Information Center (CNNIC), there were 873,4 million short-form video platform users in China as of the end of 2020, or about 88.3% of the country’s internet users. Basically, if you have an smartphone with an internet connection, you’re considered rare if you’re not on one of these platforms.

.

Another interesting difference is the user demographic. Kuaishou is well-able to attract users from poorer regions (Tier 3 and below). These regions are likely to account for the majority of the future growth, as smartphone usage isn’t fully adopted in most rural areas. We previously stated that current users of short-form video platforms is around 873,4 million. This number is expected to grow to 1.1 billion by 2025.

The above charts were obtained from eMarketer, via the following link.

Business model

Kuaishou makes the majority of its money through live streaming, virtual gifts, advertising and e-commerce. It focused on expanding its user base – “competing for eyeballs” -before fully turning to commercialization. We’ll discuss the different revenue segments in detail in the quantitative segment.

Its competitor, Douyin, has been somewhat more aggressive in its commercialization strategy. In June 2020, ByteDance set up its own ecommerce unit and introduced all kinds of mini-programs within its platform, as well as loyalty programs. Lately, more news came out of Douyin taking explicit steps to attract merchants to its platforms, bringing it into competition with Alibaba and Pinduoduo. Its platform is ideally suited to promote Merchant products targeted at the younger generation, especially teenagers.  

Douyin is also internally testing group-buying functions. If it would continue on these functions, this would put the platform in direct competition with consumer products and retail services platform Meituan.com. (eMarketer, 2021). As a side note, we don’t expect Douyin to move to group-buying functions anytime soon given the aggressive expansion move on the group-buying market – raised 10 bln USD in April – and the fierce competition from Pinduoduo.

This just shows how competitive these big platforms are, leaving smaller players little incentive to enter these markets.

Revenue Segments

As mentioned before, Kuaishou makes the majority of its money through live streaming, virtual gifts, advertising and e-commerce. With streaming, users can broadcast their gameplay to a live audience and receive virtual gifts from viewers in return (earnings category: livestreaming).

The app also has a separate games tab, allowing people to download mobile games from third parties, which in turn gives Kuaishou a share of in-app purchase revenue.

Advertising revenue is derived from its separate advertising platform and to a lesser extent from its short-video ads. It has unique data over its users, which the company puts to work by allowing merchants to target customers by segment. Revenue from this segment rose 194.6% in 2020 to ~3.2 bln (earnings category: online marketing services).

Gathering a lot of user data and using this for marketing purposes is exactly what Alibaba does with its Alimama “Ad Tech” platform. Note that for Alibaba, this advertising platform accounts for 60% of Alibaba’s total revenue. We see Kuaishou’s marketing platform as the core enabler in its path to becoming profitable in the near future.

On the ecommerce side, influencers take to Kuaishou to host live events where they promote products. Kuaishou also receives commission on ecommerce items sold through its platform. Merchants can either sell directly through Kuaishou or through third-party integrations with partners such as JD.com. Kuaishou has also partnered with Alibaba in the past, as when the companies together generated 2.1 billion yuan ($324 million) in sales from Singles’ Day 2019 (Protocol, 2021). This commission revenue falls under the “Other services revenue” category. Let’s have a look at the financial performance.

Financial Performance

The financial disclosures from previous years show that Kuaishou hasn’t posted an annual profit since 2017, though it has managed to almost double its revenue through 2017 and 2019.

Note that the bulk of its revenue is derived from livestreaming, which shows Kuaishou’s dependence on this segment. It managed to reduce its dependence on this segment in the second half of the year. In the fourth quarter, revenue from marketing services even surpassed revenue from the live streaming business. It is worth noting that its costs related to SG&A are over 50% of its revenue, which indicates the companies’ aggressive focus on customer acquisition.

Douyin, on the other hand, pulled in about 67% of its revenues from advertising last year while live streaming only made up 17%, according to a source cited by Technode (Techcrunch, 2020).  

The revenue distribution reflects the core use case of both apps. Kuaishou often prides itself on user engagement; indeed, over a quarter of its 776 million monthly users are creators themselves. That makes Kuaishou more of a social app, where the viewers and creators interact frequently through means like live streaming and gifting (Techcrunch, 2020).

On reporting its full-year results on March 23rd of 2021, the share price sank 12% as a result of the performance in the live streaming segment. Analysts were expecting a positive surprise, which the company couldn’t deliver.  We’ve covered the financial results, let’s now take a look at the stock valuation metrics.

We further note the company incurred around 2.1 bln USD in selling & marketing costs in the first 6 months of 2020, an increase of over 350% year-on-year. It went on an aggressive marketing campaign, successfully attracting more users. However, increased costs resulted in losses of over 10bln USD in the first half of 2020, a figure larger than the last three years combined. Behind these losses lie Kuaishou’s efforts to diversify its revenue sources beyond livestreaming.

Valuation

Let’s have a look at what the current price means in terms of valuation, and whether or not the stock is reasonably priced at current levels. As usual, we provide a comparison between the company and its peers. ByteDance, its main competitor, is currently not publicly traded. As a result, we added the Chinese video-sharing platform Bilibili and the well-known Snapchat to the table.  

It’s rather hard to judge on the valuation of the company, as both its EBITDA and Net Income are still negative. We note that from a price-to-sales perspective, Kuaishou is quite expensive with a P/S of over 15 but this is lower than its above competitors in both China and the U.S.

However, as the company increased its sales by 50% over the course of last year, the current number doesn’t reflect the sales growth potential. We can use an alternative metric corrected for growth, in line with the PEG (Price-earnings growth) ratio but discounting sales instead of earnings.

That leaves the question which growth rates to use. Let’s draft some scenario’s based on low, medium and high growth rates.

As you can see, a price to sales (corrected for any growth) of 15,3 is acceptable if the company keeps growing at its current rate. Less so should it only grow 10% (as the P/S Growth ratio would be more than one, indicating the price might be too high).

We can see that the growth rate is critical in coming up with a valuation metric. To better understand the implications of a 15,3 P/S, consider the following elements

• The current P/S ratio of the combined Nasdaq stocks equals 4.58 (April, 2021)
• The current P/S ratio of Netflix [NASDAQ:NFLX], for example, equals 8.4. However, Netflix is only growing revenue at a rate of around 25%.
• The current P/S ratio of Snapchat Inc. [NYSE: SNAP] equals 39,9, with earnings growing over 45 % for three consecutive years

Now this puts things in a much better perspective. The initially considered expensive “Kuaishou” becomes reasonably priced relative to the valuation of Snapshot Inc. Ofcourse, it ultimately depends to which extent a company is able to convert these sales into profits.

It’s worth noting that ByteDance, while surpassing Kuaishou in terms of DAU, has an expected market value of 400 bln USD, according to sources cited by the South China Morning Post (SCMP, 2021).

Regulatory risk

Regulation has always been a risk for businesses worldwide, but it has been increasingly driving recent market movements in China.

The Chinese government monitors the livestream industry very closely. In late 2020, it imposed rules that ban teenagers from buying virtual gifts and required them to register under their real name. In the past, Kuaishou already had to suspend its platform temporarily due to compliance issues.

We would not be surprised if the government went a step further, and issued additional limits on the time users are allowed to spend on these platforms. The regime already imposed similar restrictions to the gaming industry for minors.

Increased competition from Tencent and Douyin

Despite its’ ownership stake, Tencent has launched a number of short-form video apps in the past. These can be easily integrated into WeChat and form a sincere threat to Kuaishou. Should this relationship defer, it is likely to have a material impact on the stock price.

To date, Douyin is still the leading short-video platform in China. While we don’t believe this is a winner-takes-all market, it’s overseas success provides ByteDance with the (financial) means to continue to penetrate the lower tier cities by aggressively focusing on customer acquisition. We note that marketeers seem to prefer Kuaishou for direct e-commerce conversion, while Douyin is better for raising brand awareness and paid-for advertisements (AdChina, 2021).

Lillian Li, a popular substack author, writes it likes this:  

“Kuaishou’s product philosophy is around allocating attention to as many people as possible, so that ‘everyone has a chance to stand in the sun’. TikTok’s philosophy is about providing the end-user with the most engaging and stimulating content as effectively as possible.”

Her newsletter is called “Chinese Characteristics”, go check it out: https://lillianli.substack.com/

Douyin isn’t the only competitor though, with platforms like Joyy Inc. and Bilibili Inc. playing in the same league that is digital entertainment.

General conclusion

Kuaishou is another loss-making tech giant focusing on customer acquisition first, profits later.

Or is it?

The way in which it can keep users on its platform is unique, and especially valuable for third-party merchants. Furthermore, the company is finding a way to reduce its dependance from livestreaming and allowing its marketing platform to come to fruition.

We see 2 main catalysts for the stock. First, its competitor, ByteDance, was expected to file for an IPO on the Hong Kong exchange in the second quarter of 2021 (NikkeiAsia, 2021). However more recently, the company has downplayed expectations in this regard. On April 24^th of 2021, the company stated

“There has been recent media speculation about our IPO plans. We would like to clarify that we are not ready at this stage and do not have IPO plans yet” (SCMP, 2021)

Still, the company will eventually have to consider a listing, providing initial investors an exit opportunity while also raising more capital to face Alibaba & Pinduoduo in the e-commerce market.

Despite some analysts thinking this might be bad news for Kuaishou we believe it is rather the opposite. Often competitor IPO’s generate news attention and positive momentum for the sector as a whole, with Huobi Technology being a recent example following the – important to note – successful IPO of Coinbase.

A second catalyst is Kuaishou reporting earnings on June 21^st, 2021. If is able to keep a steady user growth while getting its costs under control, we don’t see any reason why the stock can’t rally beyond its IPO price.

Given the complete picture discussed in this report, we put a “BUY” rating on the stock on Monday close, 26^th of April, 2021. Note that this is not investment advice, and you should always do your own research before making a purchase.

Trading Kuaishou

What is likely a result of the continued US/China tensions, Kuaishou owners preferred not to list on American exchanges but instead went for a Hong Kong listing in February this year. You can find the stock under the ticker [1024.HK]. At the time of writing (23^rd of April 2021), the stock closed the trading session at 256,8 USD.

Since March, there is a secondary listing on the American OTC (over-the-counter) market, ticker [KUASF:US]. However, we don’t recommend investors to buy shares through the OTC market as trading volume is extremely low.

Investors should check with their broker whether its trading options include Hong Kong exchanges.

Trading Strategy

Alternatively to buying the stock directly, investors could also look for other trading approaches. An example of this would be to use a pair trade.

We previously stated Snapchat, with its P/S of 39, is relatively more expensive than Kuaishou with a P/S of 15,3. However, fourth quarter DAU growth for Snapchat is 21 % while it is 31,4% for Kuaishou. Additionally, full-year 2020 revenue growth for Snapchat was 46% compared to Kuaishou’s 50,2% (the latter did have a significant increase in selling and marketing cost). If one would expect the valuation of Snapchat and Kuaishou to converge, going long on Kuaishou and short on Snapchat would be one way to set up this trade to lower the total risk. An investor using a pair trade typically has a lower amount on the short end – in this case, Snapchat – as they don’t want to be market-neutral.

AdChina. (2021, 01 15). Your Guide to Marketing on Kuaishou. Retrieved from adchina.io: https://adchina.io/2021/01/15/kuaishou-marketing-guide/

Business of Apps. (2021, 03 8). Average daily time spent on Instagram. Retrieved from www.businessofapps.com: https://www.businessofapps.com/data/instagram-statistics/#9

eMarketer. (2021, 3 4). Chinese short-video apps race to expand social commerce offerings. Retrieved from eMarketer.com: https://www.emarketer.com/content/chinese-short-video-apps-social-commerce-roadmap-points-expanding-content-services-universe

Kuaishou Technology. (2021, 03 23). Kuaishou Technology Announces Fourth Quarter and Full Year 2020 Financial Results. Retrieved from ir.kuaishou.com: https://ir.kuaishou.com/news-releases/news-release-details/kuaishou-technology-announces-fourth-quarter-and-full-year-2020/

NikkeiAsia. (2021, 04 15). TikTok owner ByteDance silent on rumored Hong Kong IPO plan. Retrieved from asia.nikkei.com: https://asia.nikkei.com/Spotlight/Caixin/TikTok-owner-ByteDance-silent-on-rumored-Hong-Kong-IPO-plan

Protocol. (2021, 01 25). Everything You Need To Know About The Kuaishou IPO. Retrieved from protocol.com: https://www.protocol.com/kuaishou-ipo?rebelltitem=1#rebelltitem1

SCMP. (2021, 04 24). TikTok owner ByteDance says it has no immediate plans to go public. Retrieved from scmp.com: https://www.scmp.com/tech/big-tech/article/3130892/tiktok-owner-bytedance-says-it-has-no-immediate-plans-go-public

SCMP. (2021, 04 1). Value of TikTok maker ByteDance approaches US$400 billion for new investors, sources say. Retrieved from SCMP.com: https://www.scmp.com/tech/big-tech/article/3128002/value-tiktok-maker-bytedance-approaches-us400-billion-new-investors

Techcrunch. (2017, 03 23). Tencent leads $350 investment in Chinese photo/streaming app Kuaishou. Retrieved from Techcrunch.com: https://techcrunch.com/2017/03/23/tencent-back-chinese-instagram-kuaishou/

Techcrunch. (2020, 11 6). China’s cash-burning video sector: How Kuaishou lost $1B in 6 months. Retrieved from techcrunch.com: https://techcrunch.com/2020/11/05/kuaishou-ipo-hong-kong/