DOYU - DouYu Is Not A Buy Yet

2023-07-24 16:56:22 ET

Summary

• Positive regulatory developments have led to an expansion of DouYu's price-to-revenue valuation multiple in recent months.
• But DOYU's upside is capped by its lackluster top line growth prospects and the lack of shareholder capital return.
• My rating for DouYu is a Hold; DOYU can't be rated as a Buy, until its top line growth outlook improves, and the company is ready to return excess capital.

Elevator Pitch

I have a Hold rating for DouYu International Holdings Limited ( DOYU ) shares. I touched on DOYU's regulatory headwinds and the stock's potential downside in my prior update published on May 11, 2023.

With this latest write-up, I rate DOYU as a Hold now as compared to a Sell previously, after taking into account positive regulatory developments for China's technology sector. But DouYu doesn't deserve a Buy rating, as its revenue growth prospects are poor and the company's shareholder capital return is below expectations.

The Regulatory Environment Has Become More Favorable

I have previously downgraded my rating for DOYU from a Hold to a Sell in May. I made this decision considering that the company was the subject of an investigation by the authorities relating to inappropriate content, and that regulators had visited its branch in Hubei, China. At that point in time, there was a reasonably high probability of the regulatory valuation discount applied to DouYu's shares by investors widening in light of adverse regulatory developments.

But there have been favorable developments for China's technology sector in recent times, which should be positive for DOYU.

A July 10, 2023, Seeking Alpha News article noted that the recent fines meted out to major Chinese internet giants indicate that "China's crackdown on the technology sector is nearing the end." Nikkei Asia subsequently published a news report on July 12 this year citing comments from China's Premier that "Chinese local governments need to make the regulation of platform firms more transparent, predictable and less costly."

DouYu's consensus forward next twelve months' price-to-revenue valuation multiple expanded from 0.39 times as of May 10, 2023 (a day after the regulators' investigation of DOYU was revealed ) to a three-month high of 0.48 times of July 13, 2023. The positive re-rating of DouYu valuations coincided with the Chinese Premier's commentary on regulating technology companies referred to above. It is apparent that DOYU's share price performance and valuation multiples are very much influenced by the market's view regarding China's regulatory environment for the Chinese technology sector.

In summary, the regulatory valuation discount for DOYU's stock has narrowed, thanks to positive news flow relating to the policymakers' stance on Chinese technology businesses such as DouYu. This explains why I have made a decision to raise my investment rating for DOYU to a Hold. However, I am of the opinion that DouYu isn't worthy of a Buy rating yet as explained in the subsequent section.

Revenue Growth Acceleration And Capital Return Are The Catalysts Needed

DouYu's consensus forward next twelve months' price-to-revenue metric is 0.43 times now (source: S&P Capital IQ) . As a comparison, DOYU's three-year mean forward price-to-revenue ratio was 1.12 times. There are two catalysts required to be realized for DouYu to experience a significant valuation multiple expansion back to historical averages. In my view, these catalysts won't be realized.

One key catalyst for DOYU is revenue growth acceleration.

Based on consensus data obtained from S&P Capital IQ , DouYu's top line in local currency or RMB terms is forecasted to drop by -23.1% in fiscal 2023, prior to increasing modestly by +2.3% for FY 2024 and +3.9% for FY 2025.

It is easy to understand why DOYU's revenue growth outlook is lackluster, when one reviews the company's management commentary. At its Q1 2023 results call in mid-May this year, DouYu stressed that it will "focus on revenue stability and improvements in both gross margin and adjusted net margin" for the foreseeable future.

In the past, virtual gifts were the key source of revenue contribution for most live-streaming companies in China including DOYU. As reported by the Wall Street Journal , Chinese regulators have placed limits on the monetary value of gifts on live-streaming platforms and banned minors from sending any form of virtual gifts since last year. As a result, DouYu and its peers had to optimize their revenue mix to make up for the decrease in virtual gifting revenue. Specifically, DOYU has introduced new membership services relating to games as part of the company's plans to diversify its revenue mix and reduce its reliance on virtual gifting revenue.

DOYU will naturally need more time to reignite revenue growth during this transition period. But it is difficult for the market to assign a higher price-to-revenue valuation multiple to DouYu, when the company is expected to witness revenue contraction this year and deliver low single digit percentage top line expansion in the next two years.

The other key catalyst for DouYu is shareholder capital return.

The company had RMB6.6 billion (or close to $1 billion) of cash and investments on its books as of the end of March this year. Notably, DOYU's current market capitalization is only a third of its current cash balance.

Despite having a substantial amount of cash on its balance sheet, DouYu hasn't been returning capital to the company's shareholders in recent times. DOYU neither extended the expiry date for its 2021 share buyback program which expired on August 30, 2022, nor initiated a new share repurchase plan. In its FY 2022 20-F filing , DouYu revealed that it didn't execute on any share buybacks between end-March 2022 and March 31, 2023. DOYU also didn't mention about share repurchases at its most recent Q1 2023 results briefing. As such, it is reasonable to assume that DouYu hasn't repurchased any of its shares for the past 16 months. DOYU doesn't pay a dividend as well.

Therefore, there is a very small chance of DouYu returning capital to shareholders in an aggressive manner anytime soon.

Concluding Thoughts

Given that I don't expect both DOYU's revenue outlook and shareholder capital return to improve significantly in the short term, a Hold rating for DouYu is fair and appropriate. Positive regulatory tailwinds have already been priced in DOYU's shares for now, so further share price upside for DouYu is less likely.

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