Updated: Mar 21
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Lvji is the leading provider of online audio tour guides in China
Based on pre-COVID-19 figures, the company is profitable, operational cash flow positive and had elevated ROIC levels
The company is led by founder and CEO Mr Zang Weizhong, who still owns a ~27% stake
Sustained revenue growth potential could come from rising domestic purchase volume, ASP expansion and capturing wallet share of outbound travelers
Headline financial performance took a hit in 1H20 owing to COVID-19 and 1H seasonality but core margins remain intact
Balance sheet remains solid with zero debt, which Lvji can capitalise on for growth opportunities
Trades at an undemanding valuation of 0.7x EV/NTM Sales and 5.4x NTM P/E. Net cash amounts to HK$0.45/share or 51.7% of market cap
DCF-backed fair value estimate of HK$1.66, representing possible upside of 90.8%
Lvji Technology (Lvji) is the largest provider of online tour guides in China with an 86.4% market share by GMV as at 2018. They deploy software via the cloud to provide online tour guides with proprietary contents protected by copyrights. These include illustrated maps of tourist attractions, alongside editorial content and voice-over commentaries of various points of interest within the attractions.
As of 1H20, Lvji had over 22,000 online tour guides globally, with the majority covering tourist attractions in China, Hong Kong, Macau and Taiwan. That said, as of 1H19 they had over 2,000 online tour guides covering tourist attractions in countries like Japan, South Korea, Australia and Italy. These mainly serve Chinese tourists who travel overseas to visit tourist attractions.
Lvji's corporate video is embedded below and more information can be found at their official site at http://www.lvji.cn/en/index.
There are two main revenue streams, 1) Sales of online tour guides and 2) Sale of customised content.
1. Sales of online tour guides
Sales of online tour guides made up 98.4% of FY19 revenue. On this front, Lvji has 3 distribution channels in the form of OTAs (97.9% of FY19 online tour guide revenue), physical travel agencies (1.9%) and through their own Lvji App (0.1%).
For sales via OTAs and through the Lvji App, end users (tourists) buy Lvji online tour guides through the respective apps and websites. Revenue is recognised on a gross basis as the product of the volume of online tour guides sold and the average listing price of these online tour guides on the respective distribution channels.
For sales to physical travel agencies, online tour guides are sold in the form of activation codes, which are typically embedded in a physical card. These cards are then resold to end users. End users may use the activation codes on Lvji’s H5 mobile websites or through the Lvji App to access the online tour guides.
Lvji does not expressly disclose the identities of their main customers. However, by the descriptions provided in the IPO prospectus as well as our own diligence checks on various Chinese OTA platforms, we believe that Customer A (57.7% of 1H19 revenue) is Tongcheng-Elong (0780.HK) while Customer B (37.3% of 1H19 revenue) is privately-held Lvmama.
It is noteworthy that Lvji has exclusive partnerships with both Customer A and B, where Lvji is the sole online tour guide being sold on their platforms. With these partnerships, Lvji has control over the pricing of its online tour guide on these OTA platforms.
2. Sale of customised content
This segment made up 1.6% of FY19 revenue. This involves one-time sales of products and services like creating bespoke, proprietary online tour guide contents for tourist attractions in the form of independent apps, mini programs or H5 mobile websites. These are commissioned by administrators of tourist attractions or local government offices.
There are two main cost drivers, both of which are embedded within cost of sales – 1) Concession fees and 2) Amortisation of other intangible assets. Together, these made up 82.2% of FY19 operating expenses.
1. Concession fees
When online tour guides are sold via OTAs, these OTAs retain a concession fee for every sale with take rate of ~50%. Concession fees made up 70.5% of FY19 operating expense.
2.Amortisation of other intangible assets
Costs pertaining to development of illustrated maps, text and audio contents are capitalised under other intangible assets. The asset base is amortised with useful lives of five to 10 years and expensed in cost of sales. Amortisation of other intangible assets made up 11.7% of FY19 operating expense.
Financial Highlights - Focus Charts
1. Revenue Growth
Revenue has been steadily growing over the past few years, mainly driven by increased number of purchases of online tour guides. Unsurprisingly, revenue plunged by 56% y/y in 1H20 as volumes fell due to governmental restrictions imposed as a result of the COVID-19 pandemic.
2. Headline Gross Margin
Headline gross margin has been relatively steady, at ~47% from 2016-2018, but dipped to 42.9% in 2019. This was largely due to increased amortisation of other intangible assets as its IP asset base expanded. Headline gross margin plummeted to 4.6% in 1H20, mainly due to the effects of operating leverage arising from fixed amortisation costs being embedded in cost of sales.
3. Headline Net Margin
Net margin has largely been stable, averaging 31.7% over the years.
4. Net Cash Position
Lvji has remained debt-free while maintaining a strong net cash position over the years. As of writing, net cash per share amounts to HK$0.45 or 51.7% of market cap.
5. Cash Flows
Operating cash flow has been growing alongside rising net profit over the years. However, FCF has been negative as Lvji remains in growth mode and has been heavily investing in its IP assets.
6. Return on Capital
ROIC has been at elevated levels throughout the years.
The Snowball Investment Thesis
We believe at its current state, Lvji offers us an asymmetric reward-risk opportunity. We will discuss our reasons in this segment.
1. Proxy to China’s domestic tourism recovery
To address the elephant in the room, COVID-19 has undoubtedly shaken the global tourism market and China was the first to get a taste of the fallout. With that being said, owing to harsh lockdown measures and a pronounced healthcare response, China was able to rapidly get back on her feet, successfully flattening the COVID-19 cases curve while resuscitating the economy.
With that being said, Chinese citizens emerging from lockdown and entering into the Chinese National Day Golden Week were faced with outbound travel restrictions. This resulted in a surge in domestic consumption and travelling termed as “revenge tourism” over the extended vacation period. We note that China saw a total of 637m trips being made across the country during the holiday, with domestic tourists generating Rmb 467b in revenue. For the first seven days of the holiday, domestic tourist arrivals recovered to ~79% of 2019 levels while tourism revenue chalked up ~70% of previous year’s levels. We opine that the recovery could have been stronger if not for the 75% capacity limits set at Chinese tourist attractions, which were implemented by the government to curb further spread of the virus.
This is corroborated by promising passenger traffic data which indicates Chinese citizens’ confidence in the country’s response to the pandemic.
2. Dominant player in a growing niche market
We like the disruption opportunity that Lvji’s products present, which tips the tour guide market power scale in favour of the consumers. Its offering makes it more convenient for consumers to access quality audio tours, while drastically reducing the cost of the service.
With Lvji’s product, tourists can just use their smartphones to obtain hand-drawn maps, text introductions, voice services, real-time navigation and other services provided by Lvji’s online electronic guides. More importantly, this effectively solves the viral risks of people gathering, physical contact, and droplet transmission caused by traditional tour guides, and they are more in line with recent smart tourism initiatives.
As such, the online tour guide market China is set to grow at 46.3% p.a. from 2018 to 2023, which would widen Lvji’s addressable market.
We also note that Lvji has been able maintain its dominant market position over competitors, taking up 86.4% of the market in 2018.
We acknowledge that competition is heating up in the online tour guide market, with Lvji’s peers like 美景听听, 小鹿导游, 口袋导游 and 三毛游 gaining visibility over the years. Nonetheless, we believe Lvji would be able to sustain its first mover advantage owing to its vast and expanding tourist attraction coverage. The benefits of a wide coverage is two-fold. First, tourist attraction administrators are highly likely to remain sticky to the first successful online tour guide provider, leaving the door open to future business collaborations. Second, the provider’s strong track record would boost its chances of being chosen by leading OTAs, which would unlock new channels for revenue growth. Therefore, should Lvji achieve the critical mass of tourist attraction coverage, it would serve as a strong barrier to entry for smaller peers.
3. Resilient unit economics and scalability likely overlooked by the market amidst COVID-19
Lvji’s business has decent core gross margins of ~50%. We note that a large part of expenses are tied up to the amortisation of intangible assets comprising maps and software. As such, Lvji could benefit from substantial operating leverage as purchase volumes normalise to pre-COVID levels. We are also encouraged by the fact that core gross margins remained largely stable in 1H20, indicating that Lvji did not face pressure from OTAs with regards to take rates. Thus, we are looking past the deterioration of headline gross margins owing to revenue growth deceleration in the wake of COVID-19.
Furthermore, we opine that there would be further revenue growth opportunities as Lvji’s core offerings gain customer adoption and average selling price (ASP) expansion kicks in. We observe that Lvji strategically lowered ASPs in their OTA channels to gain market share from 2016-18, which resulted in meaningful volume-driven revenue growth. Upon signing exclusivity agreements with its OTA partners which granted it greater pricing control, Lvji was able to increase ASP by ~51% while maintaining volume expansion in 1H19. This is encouraging as it indicates that Lvji is getting closer to finding true product-market fit.
While Lvji has stopped disclosing volume and ASP figures after releasing its IPO prospectus, 1H19’s figures suggest a pivotal shift in Lvji’s pricing strategy moving forward. According to our primary diligence checks on Lvji’s OTA channels, the group seems to be creating upsell opportunities for multi-attraction online tour guide bundles according to citywide, nationwide, worldwide and overseas tourist attractions. These packages command a significantly higher ASP compared to the historical average, likely due to the higher historical sales of single-attraction online tour guides. Furthermore, we found that the lowest price for each online tour guide remained elevated at 1H19 levels of ~ Rmb 7. These findings suggest that Lvji has been able to gain pricing power, which bodes well for revenue growth in the future assuming that churn rates remain under control.
4. Significant reinvestment opportunities via overseas expansion
While the value proposition of Lvji’s offerings is obvious in the domestic travel market, we believe its products are relevant not just in China but globally as well. Chinese outbound trips are on a steady uptrend, driven by higher disposable incomes. We believe that this trend is likely to continue once an effective vaccine becomes readily available and travel restrictions are gradually lifted.
This gives rise to a larger opportunity set for Lvji to capture the wallet share of Chinese travelers heading to popular destinations overseas. Lvji has made strong headway in expanding overseas, having already covered over 2,000 overseas attractions as of 1H19. According to their IPO prospectus, approximately HK$119.3m (Rmb 101.9m) or 23.9% of the IPO proceeds would be earmarked for the development of ~4,500 online tour guides for overseas tourist attractions in key markets like Europe, Oceania and Asia. This provides some visibility on the reinvestment runway that Lvji has at its disposal.
5. Founder-led business with a significant stake
Founder and CEO Mr Zang Weizhong owns ~27% of outstanding shares, which aligns him with shareholders. We also note that Lvji managed to procure its largest customer, Customer A (believed to be Tongcheng Elong), from one of Mr Zang’s domestic business associates. This gives us confidence that he would be a suitable steward of the company.
Mr Zang also added to his shareholding in April in the wake of the broad market meltdown, purchasing 746,000 shares on the open market at HK$0.888/share. The accompanying press release noted that “he is confident about the future business prospects of the group and the current trading price of the shares does not reflect their business prospects as perceived by investors and that it presents a good opportunity for him to increase his shareholding in the company”.
6. Debt-free balance sheet with significant cash pile to fund organic and inorganic growth
Over the years, Lvji has maintained a pristine balance sheet with zero debt and currently boasts a strong net cash position of Rmb 550.5m (HK$0.45/share or 51.7% of market cap) as of 1H20. The company also recently raised a further HK$48m (Rmb 41m) from a PIPE deal. Amongst other purposes, Lvji alluded to using these fresh funds to acquire or invest in a business that would help expand its SaaS capabilities in the smart scenic spots market. This is in addition to the HK$119.3m (Rmb 101.9m) set aside for acquisitions from their IPO proceeds. Lvji’s rock solid balance sheet grants it optionality in funding future organic and inorganic growth.
7. Fundamentally sound, cash generative business
At its core, Lvji’s business is profitable and its rapid growth is accompanied by steady OCF expansion.
With that being said, FCF has been in the red owing to Lvji’s aggressive pursuit of growth to build up its tourist attraction coverage. We view these investments as necessary to defend and expand its market leadership position. Hence, we are not too alarmed about the current state of negative FCF.
We note that there were ~10,300 A to AAAAA-rated Chinese tourist attractions in 2018 and Lvji already has coverage of a respectable 4,185 of these attractions as of 1H20. As such, we believe there will be a medium-term inflection point where investments in intangible assets will slow to more rational levels as Lvji’s tourist attraction coverage expands.
Key questions to challenge the bear case
1. Is Lvji a capital-intensive, cash burning startup?
Lvji’s FCF has been sliding deeper in the red, mainly owing to increasing investments in intangible assets. These additions to intangible assets were largely driven by the capitalisation of expenses related to the development of Online Tour Guides and maps. This might have led investors to believe that Lvji is a cash-guzzling company that requires unreasonable amounts of capital to scale.
The Snowball View:
We think not. In the years leading up to its IPO, Lvji was in hyper-growth mode and heavily investing in building a vast portfolio of Online Tour Guides. We believe this is justified given that possessing a wide coverage of major A to AAAAA-rated Chinese tourist attractions is key to customer acquisition and lock-in. We believe that cash outflow related to development of maps will taper as map coverage expands.
2. Will COVID-19 negatively impact long-term gross margins?
Lvji’s headline gross margin plunged to 4.6% in 1H20 as Online Tour Guide sales collapsed due to stringent lockdown measures to blunt the COVID-19 outbreak. This is uncharacteristic of a typical fast-growing technology company and investors might be doubting Lvji’s unit economics.
The Snowball View:
No. We estimate that core gross margins from the sale of Online Tour Guides remained resilient at 50.1% in 1H20, indicating that OTAs did not exert pressure on Lvji by raising take rates. Headline gross margin only deteriorated due to the effects of operating leverage as revenue growth took a hit.
3. Do big-ticket related party transactions mean unsatisfactory corporate governance?
Lvji’s IPO prospectus showed that CEO Mr Zang owed a non-trivial Rmb 98.5m to the group. Given the recent China-related accounting scandals like what happened at Luckin Coffee, investors might have been uncomfortable underwriting a relatively unknown Chinese high-growth company.
The Snowball View:
In this case, no. The company has clarified in the IPO prospectus that the monies in question was a refund of consideration resulting from the voided acquisition of a travel agency. Mr Zang then assumed the debt payable to Lvji as part of the reorganisation of the company prior to its IPO. We note that the bulk of the balance has been returned to Lvji as of 1H20, which should allay the bulk of investor concerns surrounding corporate governance.
Lvji could not have chosen a worse timing to go public, as the travel market and the broader economy was devastated by COVID-19 soon after its listing. That said, the stock has been hammered down to downbeat valuations of 0.7x NTM EV/Revenue and 5.4x NTM P/E.
To determine Lvji’s fair value estimate, we utilised a 10-year DCF with conservative assumptions that fall far below consensus estimates. This allowed us to derive a target price of HK$1.66, representing an upside of 90.8%. We believe our valuation captures the potential value of Lvji as a cyclical laggard play but it does not consider optionality of other opportunities like its international expansion and future SaaS capabilities.
Key DCF Assumptions:
WACC of 14% - higher than Damodaran China software sector average
Terminal growth rate of 0%
Volumes take a hit in 2020E, falling below 2018 levels, before gradually climbing back with a declining factor in growth
ASPs at Rmb 7, conservatively held below 1H19 levels and pegged to the lowest product ASP found on OTA channels.
Margins take a hit due to operating leverage, slowing inching back up due to volume growth and slowing intangible asset build-up.
A copy of the financial model can be found on our Telegram Channel [HERE].
1. Corporate governance risk
Due to the wrongdoings of a few black sheep, Chinese equities have been subject to intense scrutiny from investors and regulators alike. To be clear, we are not putting Lvji and Luckin in the same basket. Nevertheless, we wish to actively challenge our own confirmation biases about the company. Here are our main areas of concern:
The co-founder of Lvji and close associate of Mr Zang, Mr Fan Baoguo, is a VP at TAL Education, a Chinese online education giant that disclosed sales fraud to the tune of 4% of FY20 sales earlier this year. TAL's internal audit revealed that this was the work of a rogue employee, who has been taken into custody by local police. While linking this incident to Fan would be a hasty generalisation, this does not preclude us from staying alert for any future warning signs.
These could come in the form of grey corporate actions like the equity fund raising announced in Oct 2020. Optically, the timing of the equity deal does not look good, coming less than a year after Lvji's IPO. However, we acknowledge that it would be hard for strategic investors to get a chunk of the company given its thin trading volume. Furthermore, raising cash in a period of economic uncertainty is likely a smart thing to do, given that Lvji has multiple high-ROIC avenues to deploy this capital to defend and capture market share.
Moreover, we find comfort in the fact that the CEO was willing to add to his position by buying up shares on the open market earlier this year.
2. Competition risk
The competitive environment is enshrouded by a fog of war given that Lvji is the only listed pure-play in the online audio guide space. However, we discern that competition ranges from smaller private start-ups like 美景听听, 小鹿导游, 口袋导游 and 三毛游 to large companies like Tencent. Amongst the smaller players, 美景听听 seems to be the most on par with Lvji given that they claim to cover ~5,000 Chinese attractions. That said, we believe that Lvji is in a good position to fend off competitive pressures from smaller, lesser-capitalised players given its strong balance sheet. Furthermore, this provides Lvji with the flexibility to go on the offence and acquire its competitors as well. Only time will tell how the competitive dynamics play out and we will respond accordingly.
3. Concentration risk
Lvji is currently highly dependent on two OTAs to generate the bulk of its revenue. Should the business relationships turn sour or if Lvji fails to renew its exclusivity agreements, we can expect a revenue cliff which would be a sticky situation to navigate. We do not view this as a big issue over the short-term as there is still some runway to the expiry of the exclusivity agreements. Moreover, its biggest customer was procured via a warm lead of Mr Zang, which we think mitigates the risk of the loss of a major distribution channel.
For now, we are inclined to view dependence on OTAs as a feature, not a bug of operating in this space. We think the dynamic of riding on OTA platforms is similar to how many Chinese companies are dependent on WeChat for mobile distribution of their products and services. Therefore, partnering with large OTAs does make sense for Lvji's go-to-market strategy as these larger platforms own the rails to broader customer reach.
1. Better than expected FY20 earnings
Lvji should report FY20 earnings around Mar 2021. Based on current downbeat valuations, the market seems to be pricing in a stark decline in revenue and profits as an extrapolation of largely disappointing 1H20 figures. However, we think the results will not be ugly given China's domestic travel recovery as well as the effects of a seasonally stronger 2H.
Medium to long-term:
1. Worldwide COVID-19 vaccine and lifting of travel restrictions
Needless to say, a global rollout of COVID-19 vaccines would be a critical first step in breathing life to the battered tourism industry. This would also pave the way for the re-opening of travel lanes and renewing consumers' confidence in travelling again. The immediate ripple effect we can expect to see in China would be the 75% tourist attraction capacity cap being lifted, while international leisure travel should slowly resume. Both scenarios would be positive for Lvji's topline growth.
2. ASP expansion due to successful shift towards sale of multi-attraction packages
Lvji seems to be finding product market fit as it saw strong volume growth accompanied by ASP expansion. This is in line with their strategic pivot towards creating upselling opportunities in multi-city/attraction guides. Continued operational excellence on this front would be beneficial for bottom line growth given Lvji's high degree of operating leverage.
3. Expanding OTA distribution
On the flipside of the concentration risk, should Lvji be able to hop onto more OTA platforms, they would be equipped with more diversified revenue streams.
In the short to medium term, we view Lvji as a potential cyclical catch-up play as the Chinese tourism industry gradually recovers. In the longer term, Lvji has the possibility of being a secular growth play should they remain steadfast in execution both locally and internationally.
Granted, any sign of weak corporate governance would undermine the integrity of the financial statements and unwind our theses. That said, if the numbers are to be trusted, we want our portfolios to be positioned for this asymmetric bet.
Thanks for reading,
Disclaimer: We are long Lvji Technology at an average price of HK$0.88. This article is not an investment (buy/hold/sell or otherwise) recommendation, this is only for educational and discussion purposes. This article is not tailored to the specific circumstances of any reader. I/we/The Snowball do/does not purport to be in the business of providing financial advice and the contents of the article should not be regarded as such.
Cover photo source: Lvji Technology
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