Zhihu increases revenue but operating losses worsen (NYSE:ZH)

Maks_Lab/iStock via Getty Images

A quick take on Zhihu

Zhihou (NYSE: ZH) went public in April 2021, raising approximately $773 million in gross proceeds from an initial public offering and concurrent private placements at a price of $9.50 per share.

The company provides an online question and answer community in China.

Until management moves toward break even while continuing to grow total revenue, the stock is likely to continue to have little upside potential.

I’m waiting for ZH in the short term.

Introducing Zhihu

Zhihu, based in Beijing, China, was founded to provide Chinese visitors with a destination to answer their questions on a variety of topics.

Management is led by Founder, Chairman and CEO Yuan Zhou, who was previously the founder of Beijing Nuobote Informational Technology Co., an e-commerce data analytics company.

The company monetizes its offering through a combination of advertising, paid membership, content commerce solutions, online education, and e-commerce related activities.

The company operates solely online, so it attracts visitors through various forms of digital marketing, including through its relationship with investor Tencent.

Zhihu Market and Competition

According to a 2020 market research report by CIC (commissioned by the company), China’s online content market is expected to reach RMB 3.7 trillion ($528 billion) by 2025, as shown in the chart below :

China's online content market

China’s online content market (CIC)

This represents an extremely high forecast CAGR of 21.4% from 2019 to 2025.

The main drivers of this expected growth are improved capabilities to encourage users to generate content [UGC]which costs less than professionally generated content and leads to greater user engagement on the site.

In addition, management believes that China’s online content community opportunity is still in the early stages of monetization “with significant growth potential” ahead of it, including a more diverse monetization profile than that of United States, which was mainly based on advertising.

As management stated in the company’s F-1 IPO filing:

Compared to the US market, where monetization is mainly through advertising, China’s online content community market has more diverse monetization channels, including online advertising, paid membership, commerce solutions content, content e-commerce, live streaming virtual donations, online gaming, IP-based monetization and online education.

The company competes with other online communities and online content producers in China across a variety of horizontal and vertical industries.

Zhihu’s Recent Financial Performance

  • Total revenue per quarter has increased over the last 5 quarters:

Total turnover over 5 quarters

Total turnover over 5 quarters (Looking for Alpha)

  • Gross margin by quarter followed a similar trajectory to total revenue:

Gross profit over 5 quarters

Gross profit over 5 quarters (Looking for Alpha)

  • Selling, G&A expenses as a percentage of total revenue per quarter increased sharply in the last quarter:

Sales over 5 quarters, G&A % of turnover

Sales over 5 quarters, G&A % of turnover (Looking for Alpha)

  • The operating result per quarter remained negative and deteriorated significantly in Q1 2022:

Operating result for the 5 quarters

Operating result for the 5 quarters (Looking for Alpha)

  • Earnings per share (diluted) also remained negative and deteriorated further in recent quarters:

5 quarters of earnings per share

5 quarters of earnings per share (Looking for Alpha)

Over the past 12 months, ZH stock price has fallen by 84.9% compared to the US S&P 500 index falling by around 11.9%, as shown in the chart below :

52 week stock prices

52 week stock prices (Looking for Alpha)

Evaluation metrics for Zhihu

Below is a table of relevant capitalization and valuation figures for the company:

Measure

Rising

Enterprise value

-$21,680,000

Market capitalization

$1,030,000,000

Price / Sales [TTM]

1.91

Revenue growth rate [TTM]

96.32%

Operating cash flow [TTM]

-$69,270,000

Earnings per share (fully diluted)

-$0.41

(Source – Alpha Research)

Comment on Zhihu

In its latest earnings call (Source – Seeking Alpha), covering Q1 2022 results, management highlighted its average MAU (Monthly Active Users) growth of 19.4% year-over-year, with more than 96% mobile MAUs.

However, the company has seen reduced growth in new users, but increased engagement and retention of existing users, which it attributes to improved recommendations via improvements to its machine learning system.

Content has increased significantly year over year, with questions and answers increasing by 36% and 30% respectively.

Notably, the board “proposed to seek shareholder approval for a stock repurchase program of up to $100 million available for the next 12 months,” indicating that management believes the shares of the company are undervalued.

In terms of its financial results, total revenue grew 55.4% year-over-year, with content commerce solutions accounting for the highest percentage of total revenue at 30.5%, followed by paid subscription and advertising revenue at 29.8% and 29.2%, respectively.

Thus, the company has truly diversified its sources of income.

However, operating losses worsened sharply in the quarter, partly due to its dual listing in Hong Kong.

On the balance sheet, the company ended the quarter with just over $1 billion in cash, cash equivalents, term deposits, restricted cash and short-term investments.

Looking ahead, management has removed guidance provided by Hong Kong market regulations.

On valuation, the stock market has punished Zhihu severely over the past year, likely in part due to its high operating losses as well as its China-centric orientation.

According to the CEO, an interesting aspect of the challenge facing the company is to “help people discuss a subject on a more positive note”, as China undergoes significant social changes and tensions.

There are questions as to whether the current uncertain social environment is weighing negatively on the company’s growth prospects, as online negativity could have the effect of turning users away from the platform.

In any event, until management moves toward operating breakeven while continuing to grow total revenue, the stock is likely to continue to have little upside potential.

I’m waiting for ZH in the short term.