TIGR, TME & China Internet: Kerrisdale Capital

TIGR, TME & China Internet: Kerrisdale Capital

UP Fintech (NASDAQ:TIGR), Tencent Music (NYSE:TME) & China Internet – Painful Promote-Off Gives Generational Shopping for Alternative

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Q2 2021 hedge fund letters, conferences and more

Current strikes by the Chinese language authorities throughout the Chinese language web area has triggered the worst sell-off for Chinese language shares since 2018, creating an incredible alternative to purchase high-quality Chinese language Web property at engaging valuations. When historic multiples resembling ahead P/E, Chinese language Web names are buying and selling at near their least expensive ranges since 2013, with a P/E valuation disparity of over 10 turns when in comparison with US Web / Software program property (at present buying and selling throughout the high 5% of their most costly historic valuation).

This Tiger grand-cub was flat throughout Q2 however is prepared for the return of volatility

Tiger Legatus Grasp Fund was up 0.1% internet for the second quarter, in comparison with the MSCI World Index’s 7.9% return and the S&P 500’s 8.5% achieve. For the primary half of the 12 months, Tiger Legatus is up 9%, whereas the MSCI World Index has gained 13.3%, and the S&P has returned 15.3%. Q2 2021 hedge Read More

The underperformance of Chinese language web shares relative to their friends over the previous few months has been dramatic:


Now we have been requested for updates to our earlier writeups on UP Fintech (NASDAQ:TIGR) and Tencent Music (NYSE:TME). As panic over Chinese language web shares has reached a fever pitch over the previous month, it’s a good time to reiterate our bullish views on TIGR, TME and, extra broadly talking, US-listed Chinese language web shares.

For nearly a 12 months now, Chinese language authorities have been passing directives and laws in opposition to probably the most highly effective Chinese language web gamers, with a long-term view on stopping anticompetitive practices from dominating the web panorama. The present regulatory tightening is unprecedented when it comes to each its length and the severity of its impression. Current actions embody a crackdown on the non-public tutoring sector, new anti-monopoly legal guidelines aimed toward Web platforms, and intensifying measures to chill housing costs.

The dominant Chinese language web corporations are nice companies which have created sturdy on-line platforms with robust community results, and are rising at increased charges than their comparable peer group within the US whereas buying and selling at decrease valuation multiples. The web’s pure means to mixture finish customers/shoppers at scale whereas making transaction and distribution prices zero, has created dominant expertise platforms and aggregators the world over with defensible enterprise fashions, together with in China. By proudly owning this buyer relationship and the demand-side economies of scale, the web platforms have expanded their choices and monetization methods to change into pure “super-apps”.

Chinese language web corporations are thought-about nationwide champions in China, driving a higher tempo of innovation throughout quite a lot of industries like retail, media, promoting, funds, and extra. Key drivers of upper progress charges embody rising broadband penetration (particularly in rural China); an increasing center class with rising disposable earnings; a fragmented, unorganized bodily retail sector; increased inhabitants density driving increased relative effectivity and decrease prices; and a rising willingness to pay for non-pirated content material.

We imagine US investor considerations concerning the variable curiosity entity (VIE) company construction amongst Chinese language American Depository Receipt (ADR) listings within the US are overblown. Enterprise fundamentals will ultimately drive the long-term money flows and valuation multiples of the Chinese language web shares. Finally, the mechanics of re-listing or twin itemizing in Hong Kong or itemizing within the U.S. won’t have a cloth impression on valuation multiples. Even when new US IPOs finish, it’s unlikely that present US-listed names must delist in any form of disorderly vogue. Now we have consolation within the VIE buildings – we expect each US and Chinese language governments will acknowledge the rightful possession of public shareholders in all situations through the VIE construction, and that any transition to a safer construction will likely be an orderly one. Regulatory considerations across the incompatibility of jurisdictional oversight (i.e. the Chinese language authorities is proscribed in pursuing authorized motion in opposition to a US-listed firm, and US regulators are restricted in pursuing authorized motion in opposition to Chinese language domiciled corporations) are wise, and each governments try to enhance upon the established order. The VIE has been a significant construction for Chinese language corporations to achieve entry to overseas capital, bringing an enormous quantity of financial profit to China when it comes to jobs, taxes, and innovation. The VIE construction has allowed a number of hundred Chinese language corporations to lift capital from abroad markets. Many of those corporations have change into leaders in expertise and nationwide champions and are key gamers in China’s quest to be seen as a world expertise chief. The VIE construction helps the broader Chinese language targets of opening its financial markets regularly, and decreasing restrictions on overseas investments. We thus see little incentive for Chinese language regulators to dismantle this construction.

The more and more frequent sharp drawdowns we’ve seen in Chinese language web shares this 12 months are irrational. Many of those companies are excellent, with shiny progress prospects and engaging long-term margins. Now we have opted to be grasping when others are fearful.

UP Fintech Holding Restricted (TIGR) – Crouching Tiger, Hidden Gem


We’re lengthy shares of UP Fintech (“TIGR”), the holding firm of Tiger Brokers. TIGR’s shares have retreated dramatically since early July with the current escalation of regulatory stress and fears introduced on by DIDI’s IPO. For the reason that finish of June, TIGR’s shares have fallen -44% and have dramatically underperformed the KWEB ETF (-26%) and its direct peer FUTU (-41%). In our view, this has left TIGR’s shares considerably undervalued (23x P/E on 2022 road numbers versus peer group common 35x) forward of what ought to be robust operational outcomes and a materially optimistic catalyst within the firm receiving a Hong Kong securities license.

We imagine Tiger has an extended runway for continued progress. Although China is legendary for its excessive financial savings charge, households have tended to put money into actual property and financial institution deposits, with equities accounting for a a lot smaller fraction of whole wealth than in Western developed markets. However as extra Chinese language buyers, particularly younger ones, change into acquainted with international capital markets, portfolios are shifting, releasing up a gargantuan addressable market. Already, Chinese language family wealth totals $78 trillion, and we estimate that in 10 years it is going to exceed $200 trillion – virtually twice the present US stage. There will likely be room for a number of on-line brokerages price tens of billions of {dollars}, and we imagine Tiger – at present valued at $2.7 billion – will likely be one in all them.

Although the enterprise mannequin stays pretty easy – income is dominated by commissions (65% of the overall within the newest reported quarter) and internet curiosity earnings, primarily derived from margin loans (20%), with bills dominated by the price of software program engineers – Tiger has begun to develop into adjoining enterprise traces, together with IPO underwriting (serving to its clients achieve early entry to newly US-listed Chinese language corporations) and the administration of worker inventory possession plans (serving a lot of those self same corporations). To make certain, Tiger has competitors, primarily from Futu, one other up-and-coming China-focused low-cost on-line dealer. However with such a big and quickly rising addressable market, competitors hasn’t stopped Tiger from persistently profitable new enterprise.

The non permanent pullback in Chinese language ADR IPOs is a manageable situation – different income, which is primarily income from US ADR and Hong Kong IPO underwriting, accounted for 16% of income in 2020, whereas consensus has different income falling to 11% of whole income in 2021 and eight% of income in 2022. Even when there have been no extra US listings of Chinese language corporations, an unlikely state of affairs in our view, the monetary impression on TIGR’s general enterprise can be manageable. We imagine quite a lot of these IPOs would nonetheless happen, simply on the Hong Kong inventory alternate as a substitute of US exchanges. The economics of every deal can be decrease for TIGR, however significantly better than a whole lack of income. We additionally be aware that the corporate’s FX alternate enterprise, the smaller element of different income, ought to proceed to develop because of the firm’s increasing consumer base. Based mostly on our evaluation, even in a draconian state of affairs the place there aren’t any extra ADR IPOs, we imagine the direct hit to TIGR’s 2021/2022 income would solely be a low- to mid-single digit proportion impression.

The issuance of a Hong Kong license is on the horizon – TIGR utilized for an HK securities license in February of 2021 and stays assured that they are going to be granted this license earlier than the top of the 12 months. Being granted an HK securities license would have a number of optimistic advantages for the corporate’s operational and monetary efficiency, together with the power to market to Hong Kong residents instantly and drive incremental internet provides. Hong Kong is a big and profitable brokerage market, and TIGR’s administration is assured that it may be a cloth driver of internet provides for the corporate. Additional, TIGR’s monetization and profitability from HK securities buying and selling and margin lending, which is at present completed by way of a partnership with IBKR, would considerably enhance. TIGR may also obtain a better allocation (and profitability) on HK IPO subscriptions.

TIGR continues to develop internationally outdoors of China at a fast charge. TIGR started to develop its buyer base outdoors China in mid-2020, and outcomes up to now have been implausible. New worldwide enlargement outdoors of China is a major driver of incremental progress and has taken over because the agency’s main progress driver. In 1Q21, the corporate added a file 117k funded accounts with worldwide accounts comprising over 50% of the overall. The addition of over 59k worldwide internet provides was up dramatically from zero worldwide accounts in 1Q20 and 18k new worldwide accounts in 4Q20. We imagine that many of the worldwide internet provides in 1Q21 have been from Singapore, the place TIGR launched their app comparatively late within the quarter (3/13/2021). App obtain information for Singapore continued to be very robust all through 2Q21, with TIGR being the #1 most downloaded iOS app within the finance class. Administration guided for 350k internet provides in 2021 with ~70% of these internet provides coming from worldwide arenas (primarily Singapore, USA, and Australia). We anticipate the contribution from geographic enlargement to develop even additional when TIGR good points a license to function instantly in Hong Kong and expands into new nations in Southeast Asia.

Goldman Sachs initiated protection on TIGR with an unfair “Promote” score on 7/14/2021 and a worth goal of $21.06. We imagine that this evaluation was predicated on backward-looking info, and fails to contemplate a number of optimistic adjustments to TIGR’s enterprise which ought to proceed to enhance its progress profile and profitability ranges over the subsequent a number of quarters and years. Moreover, whereas on the time of initiation the value goal was +3% above the place TIGR was buying and selling, GS’s worth goal right now is +18% increased than the present inventory worth.

Goldman has a very simplistic and misguided view that FUTU, with its 8% market share of retail buying and selling quantity, has saturated TIGR’s HK shopper demographic, thus limiting potential share achieve alternatives for TIGR. In consequence, GS’s monetary estimates in 2022 and past replicate minimal contribution from the corporate receiving an HK securities license. We be aware that GS is modeling 2022 internet provides to be 40% under 2021 steering, regardless of the expectation that the corporate will get entry to HK. GS numbers embed minimal margin enlargement regardless of a number of profitable and ongoing inside initiatives to extend profitability, seize a better share of inside self-clearing, and ongoing operational scale. GS believes that attributable to TIGR’s decrease operational scale, TIGR might want to proceed investing in R&D and advertising with the intention to achieve market share, thus limiting margin enlargement. TIGR’s ROA is at present depressed attributable to a decrease 3bps fee take-rate vs. FUTU at 6bps attributable to TIGR’s partnership with IBKR. We be aware TIGR expects to be self-clearing over 70% of their purchasers by the top of CY21, an enormous bounce from at present clearing 30% of its purchasers. GS’s mannequin requires TIGR to have 23-25% internet earnings margins by way of 2025 regardless of peer FUTU having >50% internet earnings margins and TIGR’s steering that requires 50% long-term internet earnings margins.

Robinhood’s current IPO indicators the continued democratization of finance, making a frictionless cellular expertise that’s quickly making investing a cultural phenomenon. Robinhood proved that the quantity of tradeable wealth within the palms of comparatively younger and tech-savvy People was massive sufficient to accommodate a brand new $30-billion participant. The chance forward in China’s nascent retail investing {industry}, with its tech-savvy millennials, is big. It’s time to step outdoors the HOOD and enter the TIGR’s den.

Tencent Music (TME) – Rock On

We’re lengthy Tencent Music Leisure (“TME”), the main streaming music service platform in China with over 800m energetic customers and family model names like QQ Music and Kugou. Along with industry-wide regulatory scrutiny, the current State Administration for Market Regulation (SAMR) ruling requiring TME to surrender exclusivity in music content material from music labels and long-term exclusivity with impartial musicians has created investor uncertainty round TME’s long-term place. With a present market share of 65% in a 2-3 participant market in an general TAM rising at over 25-30%, TME is effectively positioned for progress even when its general market share declines to 50%. The SAMR ruling de-risks additional regulatory headwinds. We imagine this presents a possibility to amass a number one international asset with enhancing unit economics driving robust working leverage, and present process a change away from a livestreaming enterprise to a recurring subscription-based music streaming mannequin.

Trying forward over the subsequent two years, TME will profit from a number of engaging progress drivers, together with the variety of paying subscribers rising 2x, a brand new advert monetization technique driving robust advert income progress, and a restoration in social leisure spending. With paid subscribers rising at a quarterly run-rate of over 5m subscribers, TME’s paying ratio (paid subscribers divided by whole month-to-month energetic customers) will quickly develop to twenty% over the subsequent 12-18 months. At that stage, TME would have over 130m paid subscribers and generate RMB 15b in subscription gross sales, up from 5.5b in 2020. Additional, China’s on-line music paying ratio compares favorably to Indonesia (15%), Singapore (50%), US/Europe (70%) and South Korea (90%). For some further context, in its UMG presentation Pershing Sq. forecast whole industry-wide paid subscriber penetration in China rising from 6% in 2019 to 33% by 2030, with ARPU anticipated to develop at a 7% CAGR.

Regardless of rising subscription income at a 30% CAGR vs. Spotify (SPOT) at 15-20%, TME at present trades at lower than half the EV/Income a number of of SPOT. If shares recuperate to their current buying and selling vary of 5-6x EV/Income, and contemplating TME’s possession stakes in SPOT, UMG and WMG at present valued at almost $2b, TME shares are simply price 3-4x their present buying and selling ranges. It’s time to show up the amount and purchase some Tencent Music.


Since asserting the $1B share buyback in March, TME purchased again $200M in shares at $17/share over a 6-week interval. We wouldn’t be shocked in the event that they’ve been shopping for again further shares by way of this current turbulence, which might act as an extra catalyst if it’s introduced throughout their August earnings report. With a brand new CEO from Tencent, and the SVP of Technique at Tencent (Jason Mitchell) now Chairman of TME’s compensation committee, TME will profit from portfolio optimization inside each audio and video, and higher synergies throughout the Tencent ecosystem. New product structure and a streamlined portfolio are anticipated to be unveiled in 3Q, making a optimistic optionality on how the general enterprise and its market alternative is considered externally.

SAMR’s new ruling mandates non-exclusive music contracts with consumption pushed pricing, whereas explicitly prohibiting prepayment of contract charges. This can successfully decrease industry-wide royalty funds, driving working leverage to TME’s long-term enterprise mannequin. In an try to achieve a dominant place in on-line music streaming, TME signed costly and unique music contracts in 2017-2018 that expired this 12 months. In distinction to the western world, the highest 5 music labels in China solely contribute 20-30% of whole play counts, thus reducing the music label’s relative bargaining energy. TME at present pays over 2b RMB in quarterly music licensing prices, and can meaningfully decrease this price whereas shifting to a extra variable price construction. TME’s quarterly sub-license income of 200-250m RMB implies that TME is ready to offset solely a fraction of its contractual licensing prices. Even a ten% discount in licensing bills will drive a 250bps enlargement to TME’s working margin. As well as, the expansion in long-form audio and inside content material creation efforts will additional decrease prices, enhance monetization alternatives, and develop gross margin over time. Be aware that within the near-term by way of 2021, gross margin possible stays pressured attributable to investments in long-form audio and better revenue-sharing charges for WeSing livestreaming (to carry it consistent with the {industry} common).

TME has additionally developed a nascent promoting enterprise that’s changing into a significant contributor to income. Administration has improved its advert stack, expanded its gross sales power, and grown CPMs, leading to promoting income rising at an over 100% CAGR since 3Q20. Unlocking further app-based monetization strategies is useful in scaling consumer base and TME’s promoting enterprise stays under-monetized vs. friends: it earned simply RMB 2.6 per consumer in 2020 vs 10+ for a lot of comparable platforms. On account of its enhancements, promoting now accounts for a majority of on-line music’s non-subscription income. Analysts estimate that promoting income might develop from RMB 1.5bn in 2020 to 7bn in 2023.


Lengthy-form audio, or podcasts, provides a 3rd driver for TME’s music enterprise. Based on iResearch, China’s long-form audio market ought to develop at a 40% CAGR over the subsequent three years. This enterprise provides increased margins than music, since long-form audio doesn’t require hefty content material charges charged by main music labels. The enterprise is at present a drag on profitability as TME invests in its progress. However its early success is clear with penetration exceeding 20% in 1Q 2020 from 5% a 12 months in the past, already attaining administration’s 2021 targets.

TME’s legacy livestreaming and social enterprise will lap COVID comps and is poised to recuperate after rising solely 10% in 2020 vs. the music enterprise rising by 30-35%. Based on iResearch, the general social leisure market is predicted to develop at over a 20% CAGR by way of 2022. Our current checks recommend month-to-month indicators like gifting quantity and energetic anchors are recovering sequentially in 2Q21. Though TME’s still-dominant platforms for karaoke and music-related content material have misplaced mindshare to short-form audio and apps like TikTok, TikTok reduce fee charges this 12 months, permitting churn to stabilize and TME’s WeSing MAUs to backside and develop once more. Whereas it stays a aggressive setting, the social enterprise is quickly studying to deal with the evolving {industry} panorama.


TME’s mixture of a grossly under-monetized music enterprise and a recovering social entertainment enterprise warrants a premium valuation. TME shares traditionally loved a premium vs. SPOT by as a lot as 5 turns to income, however are at present buying and selling at a 50% low cost regardless of increased progress charges and superior long-term unit economics. As shares recuperate in direction of their current buying and selling vary of 5.0-6.0x EV/Income, we imagine TME shares are simply price 3-4x their present buying and selling ranges.

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