Mass Layoffs at ‘China’s Instagram’: Tough Times or Primping for IPO?

Xiaohongshu confirms cutting 9% of its staff amid similar layoffs at other big internet companies. But some suspect the move may be aimed at improving its financials for an IPO

Key takeaways:

  • Xiaohongshu’s recent major layoffs could reflect a tough advertising market, even as it framed the move as normal workforce turnover
  • Others reportedly laying off large numbers of workers include top livestream gaming platforms Huya and DouYu, whose planned merger was nixed by regulators last year

By Ken Lo

China’s internet realm has become the land of massive layoffs these days. News of cuts at the top of the pyramid first appeared last month, with word of headcount reductions at internet giants Tencent (0700.HK), Alibaba (BABA.US; 9988.HK) and (JD.US; 9618.HK). Now attention has shifted to smaller but still sizable companies like Xiaohongshu, often called “China’s Instagram,” as well as game streaming companies Huya (HUYA.US) and DouYu (DOYU.US).

Xiaohongshu was one of the few to confirm its layoffs, saying it was axing 9% of its staff. It characterized the action as normal turnover, though investors were still caught off guard – especially as some believe the company may be preparing for an IPO.

Established in 2013, Xiaohongshu, whose name means “Little Red Book,” has becoming a potent force in the local e-commerce sector, both in mainland China and Taiwan, by combining online sales with social media. It encourages users to share their online shopping experiences with photos rather than words, an innovative feature imitated by TikTok parent ByteDance when it entered the Japanese market.

The platform had 200 million monthly active users by last November, according to company data, 72% born after 1990 and 50% living in major first- or second-tier cities. The company derives revenue from advertising and e-commerce. According to a research report by Tianfeng Securities, its advertising revenue in 2020 was between $600 million and $800 million, accounting for 80% of its total, with the rest coming from e-commerce operations.

Although the company has not disclosed more recent financial data, it almost certainly still gets the big majority of its revenue from advertising. That means the latest layoffs could point to shrinking of that part of its business, which will inevitably squeeze the company’s finances.

Rising valuation

The company was reportedly planning a U.S. IPO, but has shifted gears and is now considering Hong Kong instead in light of China’s recently enacted cybersecurity law. But it managed to plug any cash shortfalls in November when it sold a combined 2.5% of its shares to Tencent, Alibaba and Singaporean sovereign wealth fund Temasek. It secured a cool $20 billion valuation in the deal, double the figure from just three months earlier. Temasek’s participation was all the more surprising because the Singaporean investor had previously said it would not consider Chinese companies for a while, and had slashed its holdings in Alibaba and Didi Global (DIDI.US).

That major cash infusion appears to show the recent layoffs weren’t promoted by financial difficulties, but rather by Xiaohongshu’s desire to put its financial house in order, possibly in the run-up to an IPO. In that context, the company may be anticipating headwinds in the advertising industry, and is taking preemptive steps to get through any hard times ahead.

While an advertising slowdown may be behind Xiaohongshu’s layoffs, regulatory woes are more to blame at the big names like Tencent and Alibaba – a trend that shows no signs of slowing. The last two years have seen Beijing take harsh measures to curtail monopolies, unsavory content and illegal use of user data in the name of “cleaning the internet”.

Those steps are coming from a wide range of bodies, from traditional regulators to even China’s judicial system. For example, the Supreme People’s Court of China has barred teenagers from paying out of their pockets to play online games or reward internet hosts. At the same time, big e-commerce platforms like Alibaba have been served with massive fines for monopolistic practices, forcing them to change their habits in ways that will eat into their profits.

iQiyi (IQ.US) was one of the first to play the mass layoff game, gaining widespread attention when it cut 20% to 40% of its staff. That was followed by the reported layoffs at Tencent and Alibaba. Then there is the latest trending layoff story centered on Huya andDouYu. That pair previously tried to merge last year, but the deal was nixed by China’s anti-monopoly regulator. Now both companies are taking a hit from new policies aimed at restricting how much teenagers can spend on gaming.

Huya and DouYu account for 40% and 30% of the Chinese livestreaming gaming market, meaning their combination would have created an overwhelming leader in their space. While they are rivals, they share a common major investor in Tencent, which owns 36.9% of Huya and 38% of DouYu. The pair announced their merger agreement at the end of 2020, with Huya agreeing to buy out the weaker DouYu through a share exchange. But the two companies were forced to continue duking it out after the Chinese State Administration for Market Regulation stepped in and killed the deal.

Difficulties resulting from regulatory crackdowns and China’s economic downturn are most likely behind the two companies’ latest layoffs. DouYu lost $620 million last year, including a $193 million loss in the fourth quarter. Huya, despite posting a profit of $584 million for the year, registered a loss of $313 million in the fourth quarter, showing both companies’ situation worsened at the end of the year.

Huya and DouYu’s low valuations

Jason Chan, head of research at uSmart Securities, directly attributed the recent slowdowns in sectors like e-commerce, short videos, gaming and livestreaming to regulatory tightening.

He pointed out that internet companies’ large data troves and ability to use algorithms to target consumers with ads and induce consumption made them very popular with growth-hungry investors. But the bigger policy environment is putting a damper on that growth. On top of the revenue pressures from tightening regulation, the companies are also being forced to find ways to redistribute their wealth to broader society as “common prosperity” becomes the latest major policy pursuit from Beijing, further weighing on margins.

Chan added that Chinese companies are likely to see their revenue growth slow further as a result of policy uncertainties, resulting in depressed stock valuations when compared with U.S. counterparts. In such an environment, he urged investors to tread cautiously.

Huya is one of the few medium-sized Chinese internet companies to report a profit last year, while DouYu and livestreaming companies Bilibili (BILI.US; 9626.HK) and Kuaishou Technology (1024.HK) all lost money. Bilibili and Kuaishou have current price-to-sales (P/S) ratios of 2.7 times and 2.2 times, respectively, while the smaller Huya and DouYu have much smaller ratios at 0.53 times and 0.37 times. That appears to show investors worry that in addition to policy risk, the latter pair have the added worry of competition from each other.

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