DOYU - DouYu: Regulatory Risks Are In The Spotlight

2023-05-11 05:21:10 ET

Summary

• Regulators plan to review DOYU's platform for a month after detecting inappropriate content.
• DouYu's shares might experience valuation multiple contraction with investors' attention drawn to the company's regulatory risks.
• If DOYU's price-to-sales multiple does de-rate to its historical low registered last year, there is a meaningful downside for DouYu's stock.

Elevator Pitch

My investment rating for DouYu International Holdings Limited's ( DOYU ) stock is a Sell.

With my earlier February 7, 2023 write-up , I highlighted DOYU's "mixed 2023 outlook" considering expectations of the company's narrower loss and top line contraction for this year.

My attention turns to DouYu's recent negative regulatory development in the current article. I downgrade my rating for DOYU from a Hold previously to a Sell now. Regulatory risks for DouYu are in the limelight, following the company's disclosure of a month-long visit by regulators. In my opinion, DOYU's consensus forward price-to-sales ratio might compress significantly due to regulatory concerns, which is the key factor supporting my rating downgrade for the stock.

Negative Regulatory Development For DOYU

DouYu issued a 6-K filing on May 9, 2023 revealing that "the Hubei provincial branch of the Cyberspace Administration of China has sent an inspection team" to DOYU to "conduct a one-month on-site inspection of the Company’s content platform" in view of "certain alleged violations of content rules."

Recent media reports on DOYU provide more color on the recent negative regulatory development for the company.

According to a May 9, 2023 news article published by Chinese state media The Global Times , "pornographic and vulgar content" was found on DouYu's platform which is what led to the inspection by the Cyberspace Administration of China's Hubei division. Separately, an earlier May 8, 2023 South China Morning Post article noted that "on-site inspections (by the Cyberspace Administration of China remain a rarity" with the prior on-premises visit by the regulator occurring in March last year. Also, it is noteworthy that DOYU had previously received financial penalties from the regulatory authorities in February and April this year for violating content-related regulations as per a May 9, 2023 report by TechNode .

Based on what has been highlighted above, it is reasonable to come to the conclusion that the recent regulatory actions undertaken by the Cyberspace Administration of China against DouYu are sufficiently significant to warrant investor attention.

The Timing Of Increased Regulatory Scrutiny Is Unfortunate

Prior to this latest regulatory development, DouYu was expected to benefit from a strong new games pipeline and the company's strategic pivot in the near future. But things are unlikely to be the same going forward.

In my November 24, 2022 initiation article for DOYU, I have cited the company's press releases which describe DouYu as "a leading games-centric live streaming platform" in Mainland China. Based on research produced by Niko Partners , the number of new game license approvals (including both local and imported games) in China is projected to increase from 755 in 2021 and 512 in 2022 to more than 1,100 this year.

The expected substantial growth in new game licenses granted by the regulatory authorities in the current year is positive for the game live streaming segment in China. As such, Chinese live streaming companies focused on games in general should perform well in 2023 thanks to the greater availability of gaming content being available for live streaming. But it is uncertain whether the Cyberspace Administration of China will impose any potential restrictions on DOYU's game live streaming operations following its on-premises checks. In other words, DouYu might not be able to fully capitalize on the growing new games pipeline unlike its other peers or competitors, considering potential regulatory penalties and restrictions that the company could be faced with.

At the company's full-year fiscal 2022 earnings briefing in March, DOYU stressed that it is "increasing investments in self-produced content" in view of the fact that "the competition we face in our industry has already transitioned from gaming live streaming to gaming content." I also noted in my early February update for DouYu that the company "has a greater focus on generating inexpensive in-house content with the aim of lowering content-related expenses."

Considering that DOYU hasn't been able to effectively restrict or control illegal or offensive content on the company's live streaming platform, it is natural that DouYu's self-created content could potentially be scrutinized more carefully by regulators going forward. As such, I am concerned that the recent regulatory actions taken by the Cyberspace Administration of China might extend the time line for DOYU's strategic pivot towards in-house content.

Assessing The Potential Valuation Downside For DouYu

DouYu's consensus forward price-to-sales valuation multiple had dropped to an all-time trough of 0.29 times (source: S&P Capital IQ ) in the second half of last year, or October 12, 2022 to be exact, after China came up with new live streaming regulations. As per a September 22, 2022 article published on the China Briefing website created by professional services firm Dezan Shira & Associates , China's "Code of Conduct for Online Streamers was released to instruct live streamers with 18 guidelines and 31 categories of prohibited content."

The market is now valuing DOYU at a consensus forward next twelve months' price-to-sales ratio of 0.39 times as per S&P Capital IQ's valuation data. Assuming that DouYu's valuations de-rate to where they were the last time that worries regarding regulatory control over live streaming content was an issue, DOYU's shares could have as much as -26% downside pegged to a price-to-sales multiple of 0.29 times.

Closing Thoughts

The valuation discount assigned to DouYu's shares relating to regulatory risk factors might widen, after the company revealed that it is the subject of a recent inspection by the Cyberspace Administration of China. A review of DOYU's historical valuations suggest that the company's shares have room to decline further, and this explains why I have decided to assign a Sell rating to DouYu.

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