Meituan and Dianping were originally two separate giant companies that got merged in 2015 to become Meituan Dianping. Tencent has an 18.2% stake in Meituan. They made their public debut on the Hong Kong stock exchange (HKEX) only recently on Sep 2018. Due to a lack of stock reviews and discussions online, I felt Meituan Dianping is a growth stock which is relatively unknown to many investors. But anyone from China would definitely know what Meituan Dianping is, just like how we are familiar with Grab.
I came across this stock only recently when I was tasked to write an article about it when applying for an equity analyst position. Here is a summary of what I have gathered. I will also include my personal take on whether this counter is a good buy or not.
Background of Meituan Dianping
There is no better way to start off what Meituan Dianping is all about through their introduction video.
In a nutshell, Meituan Dianping is sort of like a super app platform that provides users with an amalgamation of lifestyle services such as booking hotel rooms, travel tickets, bike-sharing (Mobike), movie tickets (8.6% stake in Maoyan), food delivery, food restaurants recommendations, hospitality services and many more. With just a tap on the smartphone, it is able to fulfil a spectrum of what consumers need and want in their everyday life.
China is banking big on the trillion-dollar consumer service e-commerce and offline-to-online (O2O) market. The advent of super apps such as WeChat and Alipay are all changing the way consumers live, socialise, shop, pay, travel and eat. Forgetting to bring your smartphone is more problematic than forgetting to bring your wallet with your cards and cash in China.
We are still very early in the game as the online penetration of consumer services is only about 20% in 2019. A growing mammoth population and an increasing trend of smartphone users and mobile transactions paint a rosy macro outlook in the future. The paradigm shift in China’s consumerism has brought about a massive opportunity that should not be overlooked by investors. One such company that has ousted Apple and topped the most innovative companies in 2019 is Meituan Dianping.
Business Segments of Meituan Dianping
There are three main segments in Meituan Dianping business model.
- Food delivery,
- In-store, Hotel & Travel and
- New initiatives & Others.
Food delivery makes up the core business segment as Meituan Dianping has already built and operated the world’s largest on-demand delivery network in terms of the volume of deliveries. They owned two-thirds of China’s food delivery market and competes directly with Alibaba’s Ele.me. Meituan’s market share for China’s food delivery rose rapidly, doubling to overtake Ele.me. Baidu eventually sold off its food delivery segment to Ele.me as they wanted to focus more on artificial intelligence. Achieving market share dominance comes with a cost, as we will see later.
In-Store, Hotel & Delivery is like the combination of Yelp, Groupon and TripAdvisor. They work together with merchants to offer coupons, vouchers, promotions, hotel/restaurant reservations or booking of travel trips.
Lastly, New initiatives & Others, as the name implies, are service offerings that are experimental and explorative. Examples of such include online retail grocery (somewhat like Alibaba’s Hema), bike-sharing (acquisition of Mobike), car-hailing, developing cloud-based ERP systems for merchants, supply chain management and Restaurant Management System (RMS). (as seen in the introduction video)
How is Revenue Earned?
Revenue across all business segments can be classified into commissions, online marketing services and other services & sales. The basic idea is to allow merchants to display their goods and services on Meituan Dianping’s platform. The incentives for merchants are
- Stronger online presence and brand awareness
- Direct access to Meituan-Dianping’s 400 million user base
- Higher volume sales and profits
In return, Meituan earns a commission upon every successful transaction that the user makes. If this is the case, then the value of Meituan is largely dependent on the size and scale of its network effect. If there are more transacting users and active merchants, it would inevitably lead to higher gross transaction volumes, which in turn translates to higher revenue growth and profits.
How many transacting users and active merchants are the operating metrics of Meituan. Since commissions make up the highest proportion of revenue (70-80%), we have to dive deeper into understanding the inputs that drive commission revenue. According to Meituan’s prospectus, commission revenue is derived from a) Monetization rate and b) Gross transaction volume. I have summarised the annual and quarterly operating metrics of Meituan from FY 2015 to FY 2018 as shown in the diagrams below.
On first glance, the operation data looks healthy. Gross transaction volume has been increasing steadily across all three business segments. The number of transacting users and the average number of transactions per user are also increasing. Let’s dive deeper to see how the quarterly figures fare.
Operational Analysis (Quarterly)
If we compare Q1 2019 results against Q1 2018, volume for food delivery has remained stagnant while the other two segments have shown a decline in performance.
Monetisation rate has remained somewhat fairly stable for both the food delivery and In-Store, Hotel & Travel segment. While New Initiatives & Others offer the highest monetisation rate, it is more volatile as new projects come and go during an explorative phase. Finding ways and business models to achieve sustainable monetisation rate still remains a challenge for this segment.
Multiplying both monetisation rate and gross transaction volume should give us the revenue figures. Quarter-to-quarter sales revenue across all three business segments have declined, which might be an indication that the market is maturing & growth is tapering off.
Gross profit margins are not looking too good either. From Q3 FY18, it can be seen that both revenue and gross profits have stayed flattish across all business segments.
Due to the acquisition of loss-making Mobike, “New initiatives & Others” have sunken into the negative territory. Although its gross profit margins seem to be recovering, we have to wait for the subsequent quarterly results in 2019 to see if this segment turns positive.
On the overall, there seems to be a slowdown in Meituan’s financial and operational figures.
Meituan has reported staggering revenue growth figures over the past few years, but it is starting to taper off as the market consolidates and competition intensifies. To capture delivery volume and market share, Meituan has been spending aggressively on incentives and subsidies for delivery riders and users. You can see that selling & marketing expenses make up a large chunk of cost and this has led to the declining operating profit margins.
It is not unusual to see start-ups spending more than revenue on selling and marketing expenses in the initial years. The key question is whether Meituan can retain its current leadership position in the food delivery market if cost subsidies are cut back. While marketing expenses as a % of revenue have been reduced significantly, I don’t know if this coincides with the decline in gross transaction volume as we have seen earlier.
Achieving customer loyalty and stickiness is probably going to be a challenge as the switching cost is low. People would just go to whichever platform that offers more discounts, more promos, more deals, faster, cheaper, more convenient and etc.
Adjusted EBITDA and net loss are red across the years, but it seems to be recovering. The acquisition of Mobike in 2018 has contributed to a mounting RMB 4.6 billion loss. The good news is this company has very low debts (5% of total capital) and there are negligible finance costs. But I wouldn’t be sure if that is an optimal capital structure, given that we are in an ultra-low interest rate environment. Tencent has 33% Debt and Alibaba has 18% debt.
Valuations of Meituan Dianping
This is the tricky part that I think none of us would have a clear accurate answer. Firstly, Meituan is still in the early growth phase of a company’s life cycle and earnings are still negative. They are volatile, unpredictable unlike the stalwarts large companies that have consistent earnings growth. To use discounted cash flow would not be appropriate for a company of such nature.
Secondly, if we were to use the market approach multiples, Meituan is not really comparable to any companies that I have in mind. They have all sorts of business ventures and it’s like an all service in one app. It is not like a semiconductor company to another semiconductor company or a shipping company to another shipping company.
I think valuing companies in the future is going to be more and more complex. New techs, new opportunities and new stories means an overhaul in the valuation assumptions. When Uber was a fairly new company, Aswath Damodaran, the dean of valuations, got the figures all messed up. Uber turns out to have a completely different narrative rather than just a transport service company. The problem is we can’t predict the future potentials and benefits in financial tangible terms.
Comparing to Tencent or Alibaba wouldn’t be appropriate either as these two internet conglomerate has a whole array of offerings such as gaming and cloud enterprise solutions. Ele.me is under Alibaba group and is not an independent company like Meituan.
I really have no idea how best to value this company. If you have a better approach to doing this, do comment and let me know your thoughts!
Due to the requirements of the equity report, I had to choose a method and I used the most simple discounted cash flow analysis. Some assumptions on the gross transaction volume and monetisation rates over the next five years were made with different sensitivity analysis.
But to be honest, I feel that the assumptions are too arbitrary and it really defeats the purpose of even doing a valuation. There are way too many uncertainties and unknown variables in the next year, not to mention five or ten years. I don’t know how its loss-making Mobike would turn out, how aggressive Alibaba is pumping in money to Ele.me or how its new initiatives segment performs. For DCF to be meaningful, it needs at least 5-10 years of historical positive earnings with consistent growth. Meituan has not even break-even yet. So you can just ignore the 120 HKD. It’s meaningless.
The most concerning issue about Meituan is that it has yet to break-even to profitability. The company is still in a loss and its core business segment, On-demand food delivery, is facing intense competition from Alibaba.
Ele.me has stated that they are aiming for 50% of China’s food delivery market and it sets no limits on its budget to achieve that goal. Both companies are locked in an aggressive price subsidy war to compete for market share. In such a scenario, the winner is usually the one who has the deepest pocket of capital funding.
While Meituan is an independent company itself, Ele.me is just one business unit under the Alibaba ecosystem. Behind Alibaba’s venture capital is Softbank, which has a $100 billion vision fund. To compete with Meituan, Alibaba and Softbank have recently pumped in $3 billion in Ele.me to expand its outreach into smaller cities.
Alibaba’s free cash flow is net positive, and it has been increasing steadily since 2015. They have the flexibility to divert earnings from other business segments to subsidies for food delivery costs, but Meituan can’t. Its free cash flow is still negative. With rising labour costs at the backdrop, it is simply not sustainable for Meituan to burn cash continuously and play the price subsidy war in the long run. Food delivery is their core segment (60% of revenue) and they have to protect it at all cost.
To make things worse, their decision to acquire Mobike in 2018 further drags down the firm’s cash flow position and profitability margins. The good news is they are currently restructuring its Mobike business to refine pricing matrix, cut costs and improve bottom-line margins. While bike-sharing companies offer synergistic benefits and a massive bank of customer insights, the business model has yet to find a proven and sustainable way to generate consistent cash flow and profits.
Another thing that I found unsettling is Meituan’s “New Initiatives & Others” segment. In my opinion, the company is trying to achieve too many things at once. It has ventured into many non-core areas such as grocery retail, car-hailing rides, bike-sharing, micro-loans, ERP systems, restaurant management systems, delivery of raw materials in the supply chain and etc.
All of these ventures can be seen as cost diversions and it seems that they are just burning cash while trying to be the next Amazon within 5 years. For example, Meituan is closing down its Ella supermarkets reportedly due to mismanagement and low returns. They are trying to compete with Alibaba’s Hema which has been the market leader in this space.
Similarly, their car-hailing services are trying to compete with Didi Chuxing which owns approximately 90% of the market share in China. On the merchant end, Meituan is coming up with new ways to monetise its restaurant management tools by charging an annual fee. The gross profit margin from “New Initiatives & Others” is currently negative. It remains to be seen whether their explorative ventures can be turned into sustainable business models that generate profits consistently.
Even though the growth prospect of Meituan is attractive, I am still uncertain about the sustainability of Meituan’s business. “In-Store, Hotel & Delivery” is a profitable business segment with gross margins over 80%. So, I am not too concerned with that area. The two business segments that I would be watching very closely is food delivery and new initiatives.
Latest Release of Results
Just 2 days ago on 23 Aug, results for the second quarter were released and it was bullish. Meituan posted its FIRST quarterly profit since listing. Q2 revenue jumped 51% y-o-y to RMB 22.7 billion (my estimate was RMB 21.4 billion). Net profits for the quarter have risen from a loss of RMB 7.72 billion a year ago to a positive RMB 875.8 million.
Q2 gross transaction volume grew by 28.7% to 159. 2 billion. This makes 1H 2019 GTV around 297.6 billion. FY 2018’s GTV was 515.6 billion.
As seen from the dotted line, the Food Delivery segment reported a gross profit of RMB 2.86 billion, doubling the revenue figure a year ago when it was RMB 1.41 billion in Q2 18. This is really bullish, just as we thought growth was tapering down and competition is getting tough.
But Meituan’s CFO said that it was a seasonal effect and their priority is still growth over profits for its food delivery segment. China recently experienced a heatwave that has led to a surge of online food orders as people wanted to stay indoors.
Meituan is now trading at HKD 70, right around its IPO price.
Is it a good buy? Maybe. But I would be more convinced only if the company produces more consistent operation data over the next few quarters, margins start showing signs of recovery and earnings turned positive. But when that happens, price won’t be at HKD 70 anymore.
If you have a bigger risk appetite, see the future growth in China, believe that Alibaba won’t kill them, then this is something that you might want to consider.