Meitu – Crazy selfies

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Very risky proposition leaves too little on the table. 

• Meitu has 446m active users but its revenue comes almost exclusively from selling smartphones which is unlikely to convince investors to pay $6bn at IPO.
• Meitu was founded in 2008 but really came to attention with the creation of a series of apps that focus on selfies, photo editing, beauty and fashion.
• This is because its main app, Mitu Xiu Xiu, has 446m MaUs which has spawned a whole series of related apps that allow for make-up or other adjustments to be made to selfies.
• As a result of its huge success in winning users, it has filed for an IPO with the Hong Kong Stock Exchange and hopes to raise around $500m at a valuation of $5bn – $6bn.
• This is where the wheels become to come off as in H1 2016 the company generated just RMB585m ($85m) in revenues of which 95% came from the sale of 290,000 smartphones.
• Meitu made 20% gross margins on these devices which is line with the rest of the smartphone industry and leads me to believe that EBIT margins on its devices are around 2-4% in the best instance.
• On that basis alone I would not pay more than $150m valuation for Meitu but there is the app business to consider.
• A user base of 446m is potentially worth a vast amount of money but only if ways can be found to monetise those users.
• This is where Meitu is really struggling as it is currently generating RMB0.01 per user per month from its apps or around $8.5m per year.
• RFM’s assessment of the Chinese Digital Life pie estimates that the total opportunity is around RMB8.50 per user per month with 100% coverage.
• I think that Meitu’s apps cover 17% of the pie giving a total maximum opportunity of RMB1.44 per user per month.
• If I gross this up to estimate the maximum revenues Meitu could generate if it executes flawlessly, I end up with a figure of RMB7.73bn or $1.12bn per year.
• This could reasonably be expected to grow at around 7-10% per year should this goal ever be hit.
• If I benchmark this performance against Tencent, I can reach a blue-sky valuation of $9bn.
• The issue is that an IPO at $6bn means that investors are already paying 66% of the best-case scenario which I think skews the risk substantially to the downside.
• Furthermore, there are already signs of waning popularity as Meitu’s apps are nowhere to be seen in the Chinese app store charts unless one looks in the reasonably obscure photo and video category.
• Consequently, I think that the decision to invest has to be based on an assessment of the management’s ability to execute on the monetisation of its apps and even then I would be looking for a substantial discount to the proposed price.
• If I was hugely confident in the management and its ability to execute as well as fend off the threats from its far bigger and more powerful competitors (Baidu, Alibaba and Tencent), I might be convinced to pay a post IPO valuation of $2.5bn.
• Given that it raised money in April 2016 at a valuation of $3.7bn, I suspect that the IPO will have to come at a value far above that which I consider fair.
• Another IPO to avoid.