Shrinking Lemeng Faces Uphill Road To New York IPO

Key Takeaways:

• Lemeng’s revenue fell 16% in the first half of the year, accelerating from a 9% decline in all 2022, as it lost market share to larger companies
• The advertising services provider is seeking to raise $20 million in its New York IPO, even though it has yet to receive official approval from China’s securities regulator

By Doug Young

The prolonged winter for new Chinese listings in New York marches on, even as a handful of smaller companies are braving the cold with new IPO applications. One of the latest is marketing services company Lemeng Holdings Ltd., which last Thursday filed an update for its planned IPO that it first launched two years ago.

Much has changed since Lemeng made its first confidential IPO filing in December 2021. Its core advertising services market has gone into deep freeze after years of strong growth, first as companies reined in their marketing budgets during the pandemic and, more recently, as they continue to spend cautiously in China’s post-Covid economic slowdown.

At the same time, an interesting dichotomy is emerging in China’s advertising services market, similar to what’s happened in the west. Put simply, the largest companies are grabbing a bigger share of the market at the expense of smaller ones like Lemeng. Such a shift has been pressuring traditional U.S. media companies for years now, as they lost advertising dollars that were previously their largest revenue source to giants like Google GOOGL and Meta’s META Facebook that offered wider reach and more targeted services.

Data from Statista show China’s advertising market is expected to grow about 10% this year to $198 billion, quickening from 6% growth in 2022 when many advertising services companies recorded contracting revenue at the height of China’s efforts to maintain its “zero Covid” policy.

The dichotomy in China is nicely presented by growing revenue for industry giants like search leader Baidu (BIDU; 9888.HK) and short video platform operator Kuaishou (1024.HK), in sharp contrast to smaller companies like Lemeng and iClick ICLK.

Baidu’s online marketing services revenue grew 11% to 39.1 billion yuan year-on-year in the first half of 2023, rebounding from a 6% decline for all of 2022. Kuaishou was even stronger in the first half of this year, posting 22% year-on-year advertising services revenue growth to 27.4 billion yuan.

By comparison, Lemeng’s revenue contracted 16% to $32 million in the first half of the year, accelerating from a 9% contraction for all of 2022. That’s not exactly the best message for potential investors in its IPO. But such is life for a company looking for cash to help fund any future expansion plans.

To its credit, Lemeng doesn’t seem to need cash right now to fund its existing operations, as the company is relatively profitable. But those profits are falling as its revenue contracts, which doesn’t bode too well for its future unless it can get back on a growth track. The company’s profit fell 28% in the first half of this year to $2.35 million from the year-ago period, accelerating from an 18% profit decline for all of 2022.

Interestingly, Lemeng’s cost of revenue is quite high, at around 90%. That looks relatively unusual for this kind of services company, which is usually far more profitable than manufacturers. As a result of such high costs, Lemeng’s gross margin stood at just 10.8% in the first half of this year, far less than Kuaishou’s gross margin of about 50% across its entire business.

Modest Fundraising

Lemeng’s IPO plan is relatively modest, similar to most of the small number of Chinese listings in the U.S. this year. The company plans to issue 4 million shares priced at $4 to $6, which would bring it estimated proceeds of $18.6 million, according to its prospectus. A pricing at the midpoint of that range would give it a market value of $100 million.

At that valuation, the company would have a price-to-earnings (P/E) ratio of 21, based on doubling its profit for the first half of this year. By comparison, Baidu trades at a much lower P/E ratio of just 11, based on projected earnings for this year, while Kuaishou trades at a much higher 30.

While Baidu isn’t currently an investor favorite, it still seems unlikely that a company with contracting revenue and profits like Lemeng would be valued more highly. Accordingly, we wouldn’t expect Lemeng’s shares to price very strongly, and its stock is almost certain to immediately come under pressure if and when it makes it to market.

A good similar case to watch might be auto insurance provider Cheche CCG, which completed a similar-sized listing in September using a special purpose acquisition company (SPAC), raising $22 million. That listing was significant because it was the first new U.S. IPO by a Chinese company to get official approval from China’s securities regulator under new rules requiring such approval starting earlier this year.

Since the listing, Cheche’s shares have been quite volatile. But the broader trend has been downward, and at its latest close on Monday, the stock had lost about two-thirds of its value from the time of its IPO in late September. That speaks to overall weak sentiment not only for Chinese IPOs, but for all new listings in the U.S. lately – a factor that makes Lemeng’s IPO plan look even more uncertain.

Lemeng said in its latest filing that it has applied with the Chinese securities regulator for its U.S. listing, though it has yet to receive such approval. Other similar-sized companies have completed listings despite having yet to receive official approval either from the China Securities Regulatory Commission (CSRC), so that factor may not be too important.

Instead, the CSRC requirement is more targeted at larger Chinese tech companies that may hold big amounts of sensitive user data or other sensitive technologies or information. None of that probably applies to Lemeng due to its size. Instead, the company’s biggest obstacle to completing its listing probably lies in the market itself. A company with such high costs and shrinking revenue and profits is hardly the most attractive target, making it likely that Lemeng will have difficulty convincing investors to give it the roughly $20 million it’s seeking.