Huya's Fledgling Diversification Drive Shows Early Promise

Key Takeaways:

• Huya’s revenue declined 16% in the second quarter, but income from its new game-related services more than doubled
• The company is trying to diversify its revenue in the face of a softening Chinese economy and low margins

By Warren Yang

Huya Inc. HUYA has cleared a critical level in its diversification game. Now, it needs to up that game to return to revenue growth and boost its margins.

Last Tuesday, the operator of a livestreaming gaming platform reported a 16% year-on-year drop in its second-quarter revenue to 1.5 billion yuan ($212 million). That may look like cause for concern, but the results also featured a significant achievement that bodes well for the company as it attempts to return to growth after more than two years of revenue declines.

Huya’s revenue from game-related services other than streaming, such as advertising and in-game item sales, more than doubled to 308.5 million yuan during the quarter year-on-year to account for about 20% of the company’s total. This marks rapid progress in its fledgling diversification effort, which got underway just last August as it sought to counter sagging revenue from its main streaming business.

The company expects revenue from game-related services to keep growing at double-digit rates sequentially in the current quarter compared with the April-June period, acting co-CEO Huang Junhong said on a conference call to discuss the latest quarterly results.

“Overall, we are confident that the game-related services business will continue to expand in the future,” he said.

Huya is facing challenges on a number of fronts, sending its revenue into contraction mode starting in 2022 after years of growth. China’s broader gaming sector has taken a big hit in the past few years as Beijing used regulatory means to curb minors from spending too much time playing games. The crackdown also included limits on how much minors can tip their favorite gamers, dealing a blow to a major source of income for companies like Huya that take a cut of such payments.

More recently, a key difficulty for the company and its peers is the economic headwinds now blowing through China, which can dampen enthusiasm not only for gaming, but also sales of virtual gifts and other digital items that viewers buy for themselves and their favorite gamers. Such discretionary spending is broadly under pressure in China, as increasingly cautious consumers scale back on non-essential purchases in the current environment of economic uncertainty.

Low-Margin Business

These headwinds aside, Huya’s business model fundamentally involves high costs, which erode its margins to strikingly low levels for a technology company. It shares the bulk of its revenue with streamers and their agencies, and it also incurs costs for content licensing and production. These expenses leave Huya with thin gross profit margins in the low double-digit range. What’s worse, that figure is falling, to 13.9% in the second quarter from 15.7% a year earlier as production costs for self-made content grew.

The company’s newer game-related services carry higher margins, so growth of that business should eventually help Huya improve its overall profitability, even if that effect wasn’t showing up in the latest quarterly results. Demand for those services may also be less sensitive to shifts in the economic climate since they involve relationships with other businesses, which are more stable than relationships with individual, small-time consumers who are the main viewers of its streaming shows. The new products are also less prone to regulatory crackdowns.

Big Dividend

Investors cheered the quick progress Huya has made in cultivating the new business, and they also welcomed the company’s extension of an existing share buyback program.

Most of all, they probably appreciated the company’s announcement of a relatively large special cash dividend of $1.08 per American depositary share (ADS), translating to a payout of nearly a quarter of the ticker’s $4.46 close the day before the announcement. Such dividends have become relatively common among U.S.-listed Chinese companies lately, as they try to lure back investors who once were attracted simply by the China growth story.

The company’s shares jumped some 14% following the earnings release, though they later gave back all the gains and more.

Huya loses money on an operating basis, so it could clearly benefit from any gains in profitability. In the second quarter, it recorded an operating loss of 26 million yuan, although that’s about 20% smaller than the year-earlier period, the result of reductions in all operating expense items, including R&D and marketing.

The company also earns relatively significant interest income from bank deposits and wealth management products, allowing it to stay in the black in the second quarter. Its finances are in pretty good shape, with its cash and cash equivalents nearly doubling to 1 billion yuan at the end of June from six months earlier, which explains why it can be so generous with returning money to shareholders.

Huya’s financial profile is similar to that of rival DouYu DOYU. The two, which previously sought to merge in 2020 but were prevented by a regulatory veto, generate similar amounts of revenue and operate on poor margins that result in shaky profitability. DouYu also benefits from interest income, although it wasn’t enough to keep the company in the black in the first quarter.

In addition, the pair experienced abrupt losses of their CEOs last year, though DouYu’s case seemed more serious. Last November, DouYu said that its founder and CEO Chen Shaojie, who had gone missing for weeks, was arrested, with Chengu police saying he was charged with opening a gambling business.

Investors are a bit more optimistic about Huya between the two. Its shares now trade at a price-to-sales (P/S) ratio of 1.2, which is hardly spectacular but outshines the 0.9 for DouYu. The graver leadership troubles for DouYu may be a factor behind the valuation gap, but investors may also be giving Huya credit for its early success in diversifying its services.

Next, the company will need to show it can continue to beef up its new business, while still at least maintaining revenue from its main streaming services. Some higher margins would also help, showing that Huya can not only return to revenue growth, but can also start to generate profits at levels more befitting a tech company.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.