Investment in Online Games (BAIOO Family Interactive Ltd), Nov. 2020

Company: BAIOO Family Interactive Ltd (2100.HK)

Sector: Technology – Computer Services

Price (Nov. 20th., 2020): HK$0.97

Target price (12m): HK$1.6

Expected Share Price Return: +65%

Investment Risk: Medium

Rationale for investment

  • Online gaming market size is to grow at 10%+ CAGR over next years
  • COVID19 has been a rather a catalyst for the gaming industry
  • BAIOO is a regular dividend payer with low debt

Profile

Founded in 2009, BAIOO Family Interactive Limited (also known as BAITIAN Guangzhou) was listed on the Hong Kong Stock Exchange (HKEx Stock Code: 2100.HK) in 2014. The Company is a leading internet content and service provider and has been included as one of China’s Top 100 Internet Companies for two consecutive years. BAIOO’s core business covers games, animation, social platforms, artificial intelligence (AI) and other fields. Some of its key products have accumulated more than 100 million registered users.

Investment Case

The global online gaming market size is to grow at 10% CAGR to hit $79 billion by 2025. It is the fastest growing trend in teenagers and the young population globally. Although still a relatively new segment of the industry, mobile gaming has developed at an astonishing rate, with 2.4 billion people playing games on mobile in 2019. Part of mobile’s breakneck growth can be attributed to an innovative and seamless user experience which relies on engaging features such as in-app purchases and loyalty rewards.

With the 5g revolution quickly descending upon us, the increase in the penetration of the internet of things and the availability of reliable and high-speed networks are driving the demand for online gaming. Futhermore, advancements in AR, VR, and XR technologies are estimated to provide key growth opportunities for the online gaming market in forthcoming years.

In the age of big tech and loss making start-ups, I prefer a small profitable company like BAIOO with a four-year dividend payment history and a 5.1% projected yield. Core mobile games accounted for nearly 70% of revenue hence company is well exposed to the sector.

Despite the ongoing adverse impact of on the general economy, in many ways, COVID-19 has been a catalyst for the growth of BAIOO our mobile game business, and particularly for in-app consumption, which has performed remarkably well in the first half of 2020.

 The risk of regulations is real. In 2018 we were able to see China halt new video game approvals because of children’s health. The government’s main concern was myopia. The effect of games on the eye is questionable. It’s open to debate.

Gaming is still considered to be one of the cheapest ways to spend your free time. It hasn’t changed in the last decade. It’s only going to get even more favorable from a financial aspect, which is crucial in a recession. I believe the market are paying way too much attention to potential risks while underweighting the current growth and prospects, which raise an opportunity.

Valuation

The company trades at an undemanding P/E of 7.8x versus an industry average of 43x. The high discount is not fully justified by size, operating margin at 16% which is much lower that the sector 37% or ROE of 18%, which is not bad, but behind the one of the sector at 29%. The 2019 dividend was HK$0.025/share I expect to pay HKD 0.05/share in 2021 (5.1% yield). The company also enjoys low debt, high revenue growth and also conducted a buyback equivalent to around 0.9% of its market capitalization during the year.

There is limited public information on the financial outlook at company level. I make a quick and dirty estimate that the P/E multiple should double to reach a decent 15x representing, less than 50% of industry average over the next one year, which translates into a target price of HK$1.98. I further apply a 20% discount for being a relative small emerging market player hence I arrive at a target price of HK$1.6. The high top line growth should alleviate most of valuation risks.

Investment Risks

  • Security and growing regulatory compliance standards are the major challenges for the online gaming market
  • BAIOO exhibits some lack of financial transparency
  • Small industry player with lack of research coverage

I or my affiliates may hold positions or other interests in securities mentioned in the Blog. Please see Disclaimer.

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