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Professional esports players at an online game tournament. The cyber team plays computers and trains

Professional esports players at an online game tournament. The cyber team plays computers and trains

fpphotobank/iStock via Getty Images

Professional esports players at an online game tournament. The cyber team plays computers and trains
fpphotobank/iStock via Getty Images
DouYu International (NASDAQ:DOYU) has lost more than 90% since its peak of around $20 in February 2021 to today. Now it’s trading around at $1.40 per share. In my opinion, market overreaction is almost all unjustified, but presents us a great buying opportunity. The company currently trades half its cash value, and despite the drop of the number of paying users, DouYu almost broke even in the last quarter. Which means that the management is better allocating capitals by reducing costs and choosing the right/better performing investments, creating more value for the shareholders. Management’s buybacks plan might also be the catalyst that will push the stock price higher. Once the overall uncertainty goes away, I believe Mr. Market will properly price the stock.

the image describes how the eSports Ecosystem works

Image created by author using data from Douyu’s latest annual report

Image created by author using data from Douyu’s latest annual report
DouYu International Holdings Limited is the largest game-centric live streaming platform in China and a pioneer in the eSports value chain. They operate their platform on both PC and mobile apps, through which users can enjoy immersive and interactive games and entertainment in live streaming.
They essentially make money with live streaming, which generates revenue through the sales of virtual gifts, and advertisements, by offering various forms of advertising services and promotion campaigns to advertisers. They also host eSports tournaments.
The gaming live streaming audiences in 2021 were around 700 million viewers. By 2024, the global gaming live streaming audience is expected to grow to 830.3 million viewers, which means a CAGR of 5.8%.
The biggest and fastest growing market is the Asia Pacific area, with China alone accounting for almost one-fifth of the global market. The main gaming live streaming platforms in this area are DouYu and HUYA. Even though China is a mature market, the gaming live streaming audience will grow from 185.5 million in 2020 to 214.3 million in 2024.
Regarding the revenue Growth of eSports, in 2021 the global eSports market was valued at just over 1.08 billion U.S. dollars. By 2024 the market is expected to be worth around $1617.7 million.
DouYu’s growth over the last 5 years has been astonishing, compounding 50% per year. However, as we can see in the graph below revenue growth stagnated last year. The company blames this on “the recovery from the COVID-19 pandemic and the restrictions that the Chinese government has established.”

Revenue growth

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Despite the shrink in revenues due to the decrease in paying users (passing from 20.7 million in 2020 to 17.5 million in 2021), DouYu has been able to increase the ARPPU, which means that they now earn more per user (the ARPPU in 2020 was $71 and in 2021 it was $82).
If they are able to keep this metric in 2022 and reach the number of paying users they had in 2020, their turnover will be around $1.7 billion, which means a YOY of +17%.
Gross profits in 2021 were down to $170 million (-28%) compared to 2020. The reason for this decline can be attributed to the lower revenues, to the increase in cost of goods sold, and to opex. All these spendings brought the gross margins to just 12%, whereas in 2020 they stood at 16%.
When it comes to Net Income, DouYu reported a net loss of roughly $97 million in 2021, compared to the $62 million profit of 2020. This happened because they had less revenue and spent more. For instance, sales and marketing expenses increased by 64% in 2021. Moreover, the investments in product upgrades, the higher revenue sharing fees, and content costs contributed to the loss.
If DouYu’s costs had continued to rise compared to the actual revenue growth, it would have become an un-investable company. But let’s assume they had kept the same opex and costs of goods as 2020 during FY 2021. Instead of reporting a net loss, they would have been profitable. Management’s willingness to create value for the shareholders can be found in Q1 2022. In fact, revenue decreased by 16% compared to the same period of 2021, but the cost of revenues decreased by 18.0%, improving consequently the gross profit, reaching 13,6% from 12.1%.
In the balance sheet, we can see why DouYu is really appealing. They essentially have almost no debt and a huge amount of cash. According to Q1 2022, as of March 31, the company had cash and cash equivalents, restricted cash, short-term and long-term bank deposits of $996 million. Almost twice as much as the market capitalization. They can keep burning cash at these levels for more than 7 years without going bankrupt.

the chart represents the difference between Equity and Debt

Image created by author using data from Douyu’s latest annual report

Image created by author using data from Douyu’s latest annual report
Operating cash flow was negative ($92 million), compared to $102 million in 2020. The increase in costs and the decrease in revenue hit the cash flow statement badly.
Capex rose to $19.2 million, compared to $12.6 million in 2020. This is not positive as such, but since DouYu is still a growing company trying to enter new markets such as Japan, it is more than acceptable.
If we assumed for instance that they were able to get back to the FCF levels of 2019/20, we would end up with roughly $100 million. At the current price it would mean a P/FCF of 5. As owners we would essentially see a compounded 20% in return year over year.
All the data listed under financials can be found in the latest annual report.
During the conference call a few matters arose, which are worth noticing. First of all, considering the poor results, from now on the management will analyze the ROI for each game segment, evaluating optimization opportunities and improving the platform’s overall operating efficiency by enhancing ROI for each game. The reason behind the change is that during the tournaments, the users are so engrossed in watching the game that they tend to spend less time interacting with streamers, which negatively impacts on users’ willingness to pay. The management will then conduct a comprehensive evaluation of the deliverable value of each tournament, both in terms of traffic and monetization.
During the call, the management was also asked about the repurchase program of US $100 million, since as of March 31, 2022, DouYu repurchased only an aggregate of US $32.9 million worth of ADSs. The company justified the fact by saying that, due to the impact of certain SEC rules and restrictions, a large portion of the repurchase funds has been set aside for further repurchase but has not been settled yet.
When it comes to evaluating a business, I prefer to use a FCF metric because it tells me exactly the amount of cash the company can produce, without financing tricks.
So, if we take $80 million in FCF as a normal year and assume a growth rate of 5% (considering China expansion and less spending) and discount that back at a 10% rate (which is the return we want on our investment per year) and we apply a P/FCF multiple of 13, we end up with an intrinsic value of $1.3 billion. I used 13 because I want to be conservative, since DouYu is a Chinese stock. Usually, the market prices stocks with that kind of growth and financial stability with a multiple of 15.
If we divide that by the current number of outstanding shares (320m) we get around $4 per share, which corresponds to an upside of roughly 160% at the current valuation.

FCF model

Image created by author using data from Douyu’s latest annual report

Image created by author using data from Douyu’s latest annual report
If we add their net debt (-$750m), $68million of which they are supposed to use for buybacks, we get an intrinsic value of around $2 Billion or $6 per share.
Since we do not know for sure when DouYu will be able to reach profitability, we can take the amount of cash they have as a guarantee that they will not go bankrupt anytime soon.
Based on analysts offering 12-month price targets for DOYU in the last 3 months, the average price target is $1.97 with a high estimate of $2.4 and a low estimate of $1.2 per share.
DouYu’s main competitor is HUYA Inc. (HUYA). The two companies were supposed to merge, but the Chinese government stopped the merger that Tencent proposed, given ongoing antitrust regulation risks. Tencent is HUYA’s largest shareholder and owns more than a third of DouYu. The merger would have created a video game streaming behemoth worth more than US $10 billion. Now, at the current market valuation, the two companies combined are worth roughly US $1.5 billion.
HUYA has a better balance sheet, even though they have some debt. They were also profitable, but in Q42021 they reported a loss of US$37.9 million, primarily due to the increase in spending on eSports content, and the increase in revenue sharing fees. This was probably to keep up with DouYu.
The advantage of investing in DouYu compared to HUYA is the wide gap of the market capitalization. I personally think that if DouYu makes money again, they will be better rewarded in the stock market.
Let’s now try to figure out why the company trades with such a discount. The main risk that DouYu faces is the Chinese government, which might wipe out the company with a snap of fingers, like they did with the private school sector. The regulators have been implementing many restrictions, cracking down not only on the tech sector but also on gaming. They allow users under the age of 18 to play games only from 8 p.m. to 9 p.m. on Fridays, weekends, and holidays. Previously, minors could access online games for three hours on holidays or 1.5 hours on other days. But as we have seen, the restrictions did not have much impact on DouYu’s revenue, because the company makes money from streaming services, and not from actual games.
Another risk that that the company might face is the likelihood of the delisting of Chinese stocks from U.S. exchanges. If Chinese companies fail to comply with U.S. auditing rules for three consecutive years, the SEC will be allowed to delist them. Personally, I do not see that as a real problem. If the company were to be delisted, we would always be able to trade it on the OTC markets and possibly in Hong Kong, since DouYu might be considering listing there too. Let’s also remember that the Chinese regulators, as they have repeatedly said, will commit to fulfill U.S. rules for their companies.
Moreover, on May 7, 2022, the competent authorities of the PRC issued new restrictions to protect minors. Internet platforms shall, among other requirements and restrictions, prohibit minors from engaging in virtual gifting, cancel all ranking functions that rank live streamers solely by the volume of virtual gifts that they receive or rank users by the volume of virtual gifts that they send, and impose restrictions on certain interaction functions between 8:00 p.m. and 10:00 p.m. every day. DouYu expects that the new restrictions will have negative impacts on the live streaming service of the industry players.
From my point of view, DouYu is a nice play. If they are able to make money again as they did previously, the stock might be a 2/3X from the current levels. Surely, the crackdown by the Chinese government, the slowdown in revenue and the general fear across Chinese stocks has had a huge impact, but I believe that these are just current headwinds and not long-term issues. Nevertheless, the fundamentals are good and with essentially no debt and a large amount of cash in the balance sheet, so they will not go bankrupt anytime soon. Certainly the risks exist, but the payoff is much higher. Only time will tell us if we are right or not.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of DOYU either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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