Don’t Rush Into The Line IPO

  • Messaging app Line filed for IPO on NYSE and TSE, probably a few years later than it should have.
  • Line faces intense competition in Asia, disappointing top-line growth, and a significant devaluation.
  • Investors should pass on the Line IPO for now.

The Japanese messaging app, Line, has filed for IPO to go public in New York and Tokyo in July 2016. Line is one of the popular messaging apps in the wave of new messaging apps that include prominent competitors like Facebook (NASDAQ:FB), WhatsApp, Messenger, Snapchat, Chinese WeChat and QQ, Israeli Viber, and more. Messaging app was a boiling tech segment a couple of years ago when WhatsApp, Telegram, Snapchat, Line, and WeChat received incredible amounts of media attention and the buzz around these apps soared; however, as the buzz slowly faded and when a few apps took over the market, there was not much space for the various other apps.

In the past few years, investors poured massive amounts of money into this market, thinking that these apps were the future of interpersonal communication and generating revenue would be an easy task. However, as we saw from the WhatsApp acquisition and from the Snapchat's leaked financials, the messaging app is a tough business to monetize. In a recent article, I presented the case of Snapchat’s revenue growth that lags its enormous valuation and created a situation where the company could not meet its investors’ expectations and had to delay its IPO at least until 2018.

Just like Snapchat, Line monetizes messages by adding ads. However, as we witnessed in WhatsApp and FB Messenger, the company is using the messaging app as a platform for offering a wider variety of services and for generating revenues from adjacent streams like games, stickers, and e-commerce services. Line is mostly focused on the Asian markets for now, and it offers localized content, games, stickers, and advertising services. The company has two revenue streams: a content and communication segment that includes revenues from selling stickers and virtual items in games and an advertising segment that includes revenues from ads in the Line app, including sponsored stickers as well as revenues from portal ads. The content and communication segment accounts for 70% of the company’s revenues. Line expects to benefit from the expected rise in mobile content consumption which is projected to surge from $75.6B in 2015 to $256B in 2020 in paid content as shown in the chart below.

Line_chart 1_061416

Line’s second revenue stream – the advertising segment – accounts for the other 30% of the company’s revenues. The rapid growth of the Japanese mobile advertising market, which is expected to double in size between 2015 and 2020 as shown in the chart above, should drive revenues higher in this segment. Other major markets for Line, such as Taiwan, Thailand, and Indonesia, should experience the same uptrend but on a lower scale than Japan. Line’s strength in Southeast Asia, as well as its broad offering that does not depend on advertising alone, is its main advantage over the Snapchat and Facebook apps. However, Tencent's (OTC:TCEHY) popular messaging app, WeChat, and the South Korean KakaoTalk are also eyeing the Southeast Asian market as they expand globally, and Line is expected to encounter tough competition in trying to expand its user base beyond its current 218m MAU.

Looking at Line’s financials, we can see that the company has increased its top line figures at an impressive pace of 35% CAGR alongside improving net margin and adj. EBITDA margin. While the margins are attractive, Line's CAGR is disappointing for a company that operates in one of the hottest tech segments, with significant market share, and is supposed to present an exponential growth rate.

Line_chart 2_061416

The disappointing revenue growth has affected the company’s valuation, which is expected to come in significantly lower than the $9.8B valuation from 2014 when the company previously filed for an IPO in Tokyo. That decrease is following the devaluation trend among many tech unicorns, and such a substantial drop in valuation, from $9.8B to $5B, should raise a red flag. Current estimations project a valuation of $5B, which reflects a P/S ratio of 4.5 based on TTM revenue of $1.1B. This revenue multiple might seem attractive at first glance; however, investors should question whether a messaging app with a limited target audience that competes with two very local players (WeChat and KakaoTalk) and two very strong global players (Snapchat and Facebook) could grow significantly to justify investors’ money.

Line plans to use the IPO proceeds to expand globally and repay existing debt – however, in the current status of the messaging apps market, I’m not sure that users worldwide are even interested in testing a new messaging app that provides a tiny added value to them. There are currently plenty of messaging apps that offer different features and value-added services like in-app ride-hailing, app interaction, payment services, etc. that make Line’s growth story unsustainable for the long-term as long as the company does not offer any unique experience. With such an enormous uncertainty, massive competition, and not-so-impressive financials, investors should not rush into this IPO, which I expect will suffer from light demand as the buzz and hype around the company and sector fade throughout the years. A very attractive pricing might slightly change the thesis and make Line a speculative move some investors would like to make; however, most investors should pass this IPO for now. I will revisit my thesis once the IPO pricing is published.

Lior Ronen Lior Ronen   on Amigobulls :
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