The growth in China’s internet market has been phenomenal in the last couple of years as more and more people are jumping in to catch up with tech trends. Companies that operate in e-commerce, smartphones, mobile gaming etc. have come into the limelight as a result of the surge in China’s internet adoption. However, it doesn’t seem that this pace would decelerate any time soon because there is an entire half of the population that still lives without the internet. Even Cheetah Mobile (CMCM, Financial) has impressed analysts and investors with consecutive earnings beat. Yet, the stock has declined more than 25 percent from its peak in mid-November. Let us analyse whether Cheetah Mobile is a worthwhile buy in current scenario and after this decline.
Third quarter highlights
In the third quarter, Cheetah comfortably beat the Street expectations by securing a revenue growth of about 158 percent Y-o-Y and 35.9 percent Q-o-Q. In addition, mobile revenues increased by 627.7 percent Y-o-Y owing to enhanced advertising revenues in the overseas market. For the quarter, mobile accounted for 24 percent of Cheetah’s overall revenue. In the world of advertising, data is the all-pervasive force that enables higher revenue. Even for Cheetah, the mobile user base is expanding. As data shows, mobile monthly active users ("Mobile MAUs") increased by 183.9% year-over-year to 340.7 million as of September 2014.
Mobile advertising: The cornerstone for growth
According to App Annie, Cheetah Mobile was once again the No. 1 publisher for mobile apps in the Tools category on Google Play by worldwide monthly downloads in September 2014. Recently, our flagship app, Clean Master, has also reached an important milestone of 100 million daily active users. This clearly shows that Cheetah’s presence in the mobile ecosystem is growing and company’s continued focus on improving its mobile user base will bring in greater ad revenues in the coming quarters.
Recently, Gartner published a report that said global mobile advertising spending is forecast to reach $18.0 billion in 2014, up from the estimated $13.1 billion in 2013. The market is expected to grow to $41.9 billion by 2017. Gartner said that display formats will make up most of the revenue, but video will show the highest growth. In order to leverage this opportunity, Cheetah has forged alliances with leading Chinese internet companies. These partnerships will definitely bolster Cheetah’s popularity among customers and thereby ramp up its user base further. Besides partnering with the Internet companies like Baidu and Alibaba, the company has also tied up with mobile makers in order to promote its apps. It has entered into relationships with India-based Karbonn and Lava and Taiwan-based HTC to promote its apps. The company expects the current partnerships along with the upcoming partnerships to dramatically expand the reach of its apps.
Getting into gaming
The Chinese mobile gaming market is expected to grow 93% this year to $2.9 billion. Over the next four years, the market will grow at a CAGR of 37.6%. This is an important opportunity for Cheetah to enhance its mobile business and monetization, since mobile games are a good medium of displaying ads. In here as well, the company is trying to enhance its presence by acquiring or merging with considerable players in the industry.
Cheetah and its Kingsoft (which has a 48% stake in Cheetah) have announced on October 15 that they have entered into a joint operation framework agreement. As per the agreement, Cheetah will retain 50% to 80% of the generated revenues and pay licensing fees to Kingsoft per game. The partnership puts Cheetah in a favourable position to grow its mobile business going forward.
Explaining this deal, Cheetah Mobile's CEO, Mr. Sheng Fu said, "The large and growing user base, coupled with increased user engagement, enables us to become an increasingly effective mobile marketing platform for third party apps and games, while also strengthening our own game publishing capabilities. As we further expand our game publishing efforts, we believe that this partnership will greatly benefit both companies."
Takeaway
It is beyond doubt that, for a growth-oriented company like Cheetah, the opportunities presented by growing advertising needs are huge. As such, Cheetah is well placed to generate gains from mobile and PC advertising. In spite of these positives, Cheetah’s hefty valuation has become a deterrent to investment in the stock. The company has a trailing P/E ratio of about 216 and a high price-to-sales ratio of 9.83. On a forward P/E basis, Cheetah trades at a reasonable earnings multiple of 23. Also, in the next half decade, the company's earnings are expected to grow at a compound annual rate of 130%, way ahead of the 20.56% industry average.
Analysts might debate that this is an overwhelmingly expensive valuation but considering that Cheetah mobile is a fast-growing company, the valuation should reflect calculations for the same. Considering that the company is still at a nascent stage, we need to look at the EV/Revenue multiple. As for now, the company is trading with a multiple of around 7.71, which is pretty impressive of a company looking at supernormal growth. Accordingly, I would rate “Cheetah Mobile:” as a valuable buy because of its exponential growth in advertising revenue and potential to leverage the growth in Chinese internet market.
