Article / 12 December 2014 at 1:22 GMT

The bull and bear case for the Momo IPO

China Watcher / Shanghai
China
  • The feature that sets Momo apart is its social events promotion
  • Momo is successfully converting monthly active users to daily active users
  • It's worth being bullish about the long-term outlook for Momo, but be wary of the hype surrounding its IPO

By Neil Flynn

China’s instant messaging app Momo (陌陌) held its IPO on Thursday, and I expect that investors will pay close attention to the listing, as it will be a gauge of how Wall Street views the all-important mobile industry in China. I previously wrote an introduction about Momo in a previous article, which I would encourage investors to read before analyzing the bull and bear case of the IPO. 

The bull case

One of the main reasons why the IPO has received so much attention is because Alibaba is a major backer of the firm. This is important for Momo, because whilst it was originally a hookup app not dissimilar to Tinder, it has developed a more socially acceptable reputation, with users being able to chat with friends, find local events, and meet new friends with similar interests. It is, in essence, the most complete social app in China. I say that because WeChat is more designed for users to connect with people that they already know.

WeChat has a feature called ‘Look Around’, which allows users to find people nearby who have also used the feature within the last 15 minutes, and hence you can begin talking to nearby people also looking for new friends. Until two years ago, the feature was very popular, and as I live in central Shanghai, I could quite easily find 50 new friends within a 500m radius.

However, the feature has become a lot less popular, and as you can see below, there are only a handful of people within the last 15 minutes that have used ‘Look Around’ who are within 500m of me. We can contrast that to Momo, which has currently shows around 30 people who are looking to meet new friends within the last 15 minutes who are within 500m from me, with the screenshot below showing that the four closest people to me have used the service within the last minute.

Comparing WeChat‘s (L) and Momo’s (R) functions to find new friends.
Comparing WeChat & Momo
 Source: WeChat and Momo

I believe that this shows how Momo is establishing itself as the top application to make new friends. However, the feature that I believe really sets Momo apart is social events promotion. Users can search for upcoming events based on their interests, such as music festivals and wine tastings, and can join the event’s social group. Users can therefore discuss the event and find new friends to go with, which gives the app a distinct advantage over WeChat, as WeChat doesn’t cater for users wanting to make new friends.

Momo’s growing user base is a major driver of bullish sentiment. Since the first quarter of 2013, Momo’s compounded quarter growth rate for monthly active users and daily active users is 28.94% and 32.56% respectively. This shows that Momo is successfully converting monthly active users to daily active users, with the ratio between the two increasing from 35.88% in the first quarter of 2013 to 42.36% in the third quarter of 2014. This is due to the company rebranding itself as a more ‘family friendly’ app. 

Momo's User Growth
Source: Momo IPO Prospectus  

The bear case

The instant messaging app market in China is fiercely competitive, and whilst WeChat is the most popular, both Chinese and international names are widely used. NetEase shut down its Twitter-like microblogging service to focus on its Yixin messaging application, and recently offered China Telecom users 300RMB ($48.78) of phone credit for downloading the app. Alibaba has been running its Laiwang messaging app for several years, but it has failed to break WeChat’s dominance, and Whatsapp is available in China, although its more popular with expatriates and users with friends in the West.

Momo still has a long way to go in terms of challenging the market leader, as its 60.2m monthly active users is just 12.9% of WeChat’s 468m monthly active users. By having Alibaba has an investor, it does raise the possibility that Momo may one day connect users to Alibaba’s other services such as shopping and online video.

Tencent has fully integrated WeChat with its other services, such as JD.com and Tencent’s large online gaming business. In addition, it should be noted that Alibaba has previously challenged WeChat with its Laiwang messaging app, of which I don’t personally know any users, and has invested in Weibo, which hasn’t been able to compete with WeChat’s user growth over the past few years. Therefore investors should be aware that there is no guarantee that Momo can challenge WeChat.

Momo’s biggest problem is that it is posting huge losses due to large marketing expenses. This isn’t uncommon for app developers, but given that it is about to go public, it places pressure on the firm to generate net income sooner rather than later. Its revenues are mainly driven by member subscription fees, which accounted for 63% of revenues in the first six months of 2014. The paying membership service began in July 2013, and the number of subscribers currently stands at 2.3m, which is just 9% of daily active users. 

The benefit that WeChat has over its soon to be listed rival is that it is fully integrated into the Tencent ecosystem, which means that it doesn’t need to rely on membership subscriptions. If given the choice between like for like apps, users will always prefer not to pay for premium membership, and I believe that this is a risk with Momo’s service.

Its other revenue, which includes emoticon purchases and marketing revenue, accounted for just 5% of total revenues for the first six months of 2014, and I believe that the firm needs to grow this contribution in order to remain competitive in the long run. Whilst the firm claims that subscriptions give users access to premium features, regular users will attest that having premium membership stops spam accounts from contacting them. Therefore I would rather see the company focusing on improving the free service instead of charging users to solve the problem, whilst at the same time increasing the contribution of marketing to total revenues. With the fierce competition in the market, service quality is key to maintaining a large user base.

Momo's Finances

Source: Momo IPO Prospectus

The bottom line

The Momo IPO comes down to one thing: can Alibaba turn Momo into a genuine rival to Tencent’s WeChat? The simple answer is that Momo certainly has the potential to do so, and potential is what investors are purchasing at the IPO. 

In terms of its service, I believe that Momo has a lot of potential, particularly given that it is still shedding its seedy reputation. As it becomes even more socially acceptable, Momo’s user base will grow, and I expect it to rival WeChat in the instant messaging app space because it provides a much broader social service. 

However, Momo ended its first day at $17.02, giving it a market cap of $3.17bn, which is a lot for an app developer haemorrhaging cash. Whilst there may be a lot of hype surrounding the IPO and its famous backer, it will eventually fade away and I would be very surprised if its market capitalisation remains that high by December 2015. Nevertheless, I do expect it to grow in popularity, and as the service is further monetised, it will likely be profitable within a few years. Therefore whilst I am bullish about the long-term outlook for Momo, I would warn investors about getting caught up in the hype surrounding its IPO. 

-- Edited by Adam Courtenay

Neil Flynn is head equity analyst at Chinese Investors. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform
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