In a recently published Tao Value‘s Q1 2019 Investor Letter, which you can track down here, the fund reported being up 14.03% in the first three months of the year. Aside from reporting beating its benchmarks, the fund shared its views on several companies in its portfolio, including YY Inc. (NASDAQ:YY), for which it said the following:
YY returned +37.8% over Q1 2019, a sharp reversal from its dreadful 2018 performance. One major update from 2018 Q4 earning release is the acquisition of the rest 68.3% of BIGO, an international equivalent of YY Live has seen “continuous rapid growth” quoting management, especially in Southeast Asia, for a valuation around $2 billion.
As a shareholder, I was excited about the rumors of this deal as YY could leverage its operating expertise to the same but fast-growing business model overseas. While the notional valuation may seem reasonable given Bigo’s business’ high growth and high margin (we are yet to see it in formal filings, however I expect it could be similar to early years of YY Live), the payment method however makes no sense for external shareholders. For the price tag of $1.543 billion, YY decided to use $343 million cash + 38.3 million class B shares (issued to YY CEO David Xueling Li) + 331.9 million class A shares (issued to Li and other owners of Bigo). Backing it out, YY shareholders sacrificed 21% of the existing ownership for only $1.1 billion in this deal, which is translated to only $63 per ADR, almost the lowest of the year. When the management is on the receiving end of the shares (as a currency for the deal), they surely like the currency to be as undervalued as possible (so they could get as big a piece of YY as possible). If the company sells its shares (in this case in exchange of Bigo ownership) when they are so undervalued, part of the existing shareholders’ (read ours) value is unfairly transferred to the receivers of the shares (read the management). While management did indicate that “majority [of its well over $1 billion cash] are sitting onshore”1 which is hard to tap into for overseas deal given Chinese government’s ever more restricted asset outflow policies, using the cheapest price of year of YY (which could be even determined retrospectively) in the transaction clearly reveals management’s self-serving incentive. This is the exact corporate governance (System factor) risk that I worried when I evaluated this company initially.
Nevertheless, such “cheating” is not unexpected as we’ve known better when dealing with any Chinese businesses (and governments, for that matter). My mantra has been “Always assume management will steal because they mostly will.”
YY is a company that offers superior live streaming social media platform in China, constantly being the best in terms of industry metrics, such as the number of active users for example. Year-to-date, the company’s stock gained 36.25%, on April 24th it had a closing price of $83.96. Its market cap is of $6.81 billion, and it is trading at a P/E ratio of 20.78.
At the end of the fourth quarter, a total of 24 of the hedge funds tracked by Insider Monkey were long this stock, a change of -4% from one quarter earlier. By comparison, 21 hedge funds held shares or bullish call options in YY a year ago. With hedge funds’ capital changing hands, there exists an “upper tier” of notable hedge fund managers who were adding to their holdings substantially (or already accumulated large positions).
Among these funds, Alkeon Capital Management held the most valuable stake in YY Inc (NASDAQ:YY), which was worth $37.4 million at the end of the third quarter. On the second spot was Lakewood Capital Management which amassed $24.8 million worth of shares. Moreover, Renaissance Technologies, Sylebra Capital Management, and Kerrisdale Capital were also bullish on YY Inc (NASDAQ:YY), allocating a large percentage of their portfolios to this stock.
This article is originally published at Insider Monkey.