My current favorite stocks

Are in China, ugh

I’ve always avoided investing in China since my one time dabble in Alibaba. I don’t like the extra risk of the VIE structure, but that’s a minor point. More specifically I feel the risk of fraud is higher, and my tools to detect it in Chinese companies are less capable. I love buying companies at or near their net current asset values, but how do I know the claimed cash amounts are real in China?

And also, even if I have confidence in their financials, how can I have confidence that management will do the right thing with their cash/earnings? I’m not just looking for cheap stocks, I want catalysts that will drive the market to agree with my valuations, and they usually require shareholder oriented management decisions.

Well I finally found two Chinese companies that I feel are exceptions enough to purchase.

The first is MOMO (Hello Group), basically the Tinder of China. Its business has suffered heavily from competition and regulation, but it’s still profitable. The last 12 months its diluted earnings were $1.10/share (ADS actually), giving it a PE of 6. But wait, it gets far better than that. Its current assets plus investments gives it a (semi) liquid net cash value of $7.37 per share, significantly higher than its current $6.80 price, so we are getting the business for free even if we discount the long term investments by 10%.

At this point you might be thinking, so what? Wasn’t I just discussing how I don’t trust their financials? Well in this case, MOMO is giving me some special confidence, by paying large annual special dividends. This year they paid $99M, and over the last 5 years they’ve paid out roughly $700M in dividends. That is all good evidence that their substantial cash flows and balances exist.

But even better, it should be a catalyst. This year the distribution 54 cents per ADS, at current prices a yield of 8%. So over time I’ll get paid a nice return while I wait for the market to agree with me, and it’s more likely to agree as yield chasers discover MOMO. But MOMO has another catalyst, share buybacks. Management hasn’t just announced one, unlike most companies they’ve been diligent and buying back shares, esp. when it’s below $6. So in combination I feel there is two strong catalysts that will eventually get it to my target valuation range of $15-$25, and that I have a management team that is strongly shareholder oriented.

Of course MOMO still has the VIE risks, currency risks, and declining revenues. But despite those declining revenues management has skillfully reduced headcount to maintain constant profitability. It also has entrenched founders with voting control, but I’m okay with that if they keep doing the right things.

The other Chinese stock I’ve bought is Weibo (WB), the Twitter of China. Its almost an identical situation, but less obvious because its balance sheet value is a bit hidden. It has a large ownership in INMYSHOW carried at $350M that appears to be worth about $1.2B more than that. If I’m right about that, its (semi) liquid net cash value per share (current assets + long term investments minus liabilities) is in the $7-$13 range, while its currently trading at $7.70. And WB’s current yield is even higher, about 10% based on this year’s 82 cent special dividend.

But it’s not quite as good as MOMO in other respects so I sized the position a bit smaller. It’s only been paying special dividends for two years, and hasn’t done any significant buybacks. And its controlling shareholder took SINA private in 2020 at a price some regarded as a take-under, so I have less confidence in management here. But its business is a bit stronger, revenues have declined but not as much as MOMO’s have.

So I’m excited to see what finally buying into China yields me. There are still other risks. Further erosion in the value of the RMB will lower yields/valuations, and that could happen if the next president launches a trade war. But I feel like I’m not just getting these businesses for free, but with a significant margin of safety beyond that so I’m willing to hold and see what happens in the next year.