Prominent Meitu Investor Trims Stake After Years of Only Filtered Profits

Lee Kai-Fu, a former senior Google executive-turned-venture capitalist, has slashed his stake in the beauty app operator as it continues struggling to turn a profit

Key Takeaways:

• Prominent venture capitalist and former Google China chief Lee Kai-Fu has cut his stake in Meitu to 0.52% from 0.75%
• While the company touts that it has become profitable on an adjusted basis, it continues to make net losses under internationally recognized IFRS standards

By Warren Yang

Beauty app maker Meitu Inc. (1357.HK) can touch up its financial reality only so much for investors who have waited years for the company’s first real profits.

One prominent investor may be losing patience with the company as it continues to lose money years after it went public, causing its shares to sag to well below where they traded at their flashy market debut. Lee Kai-Fu, a venture capitalist who formerly was a senior Google executive, slashed his stake in Meitu, which he acquired prior to the software maker’s 2016 IPO, to 0.59% from 0.75% last month, and further cut it to 0.52% this week, according to a Tuesday filing to Hong Kong’s stock exchange. Lee remains on Meitu’s board as a non-executive director.

The share sales could reflect broader investor frustration with Meitu’s not-so-pretty struggle to become profitable – a major factor that has weighed on its stock price. At the same time, the company is doing its best to convince investors it has the right stuff to operate in the black.

Back in March 2021, Meitu touted making its first annual profit in the prior year, but with a major caveat. That caveat was that the net profit was on an “adjusted” basis and not using international financial reporting standards (IFRS), the equivalent used in Hong Kong of generally accepted account principles (GAAP) in the U.S. But under IFRS standards, Meitu remained in the red, not only in 2020 but also in every reporting period since then through the first half of last year. 

While it’s not uncommon for companies to report such alternative profit measurements, the problem is the lack of a single standard, which means they can exclude any items that are normally part of IFRS rules but they feel shouldn’t be counted in determining their true profitability. That’s why investors rely on IFRS-based figures to compare companies across different locations and sectors in uniform apple-to-apple terms.

For example, Meitu’s adjusted net profit excludes impairment losses on investments, most notably cryptocurrencies. The company made a $100 million bet on bitcoin and ether in 2021, which both resulted in big losses as digital currencies tanked in value.

Such investments aren’t part of Meitu’s main businesses, so the company probably believes it is justified excluding them from its profit calculations because they are not representative of its operational performance. But putting money into the crypto market was a strategic – and somewhat controversial – decision Meitu made to diversify its income sources under pressure to find profits.

Meitu’s shares are down more than 80% from their IPO price despite multiple buybacks to support the stock. And the company doesn’t pay dividends. So many long-term shareholders like Lee have lost large sums of money post-IPO – a far cry from the big returns they hoped to make from dividends or price gains in the stock.

Big loss

It’s not entirely clear when Lee acquired his Meitu shares. But he appears to be among the investors who participated in the app maker’s last fundraising round before its IPO, given that the equity offering was completed in June 2016, and he joined the company and became a board member shortly after that. Investors at that time bought their shares at about HK$7.40 apiece, according to Meitu’s IPO prospectus. Based on that price and Lee’s average selling price of HK$1.50 in his recent sell-down, he would have lost 80% loss on his investment.

Meitu’s stock closed at HK$1.51 on Tuesday, roughly at the same level of Lee’s average selling price. The stock has more than doubled from a low at the end of October amid a broader recent rally for Chinese tech companies, which may have also been a factor in Lee’s decision to sell.

Meitu was previously best known for its app that allows users to manipulate their selfies, offering a combination of Instagram-style simple filters with retouching techniques found in Adobe Photoshop. But despite the app’s huge popularity, Meitu has had difficulty monetizing it and its other software products, forcing the company to search for other routes to profitability.

In one drastic move, Meitu started a smartphone business in 2013, making and selling phones with high-resolution cameras, which became its main revenue source in the following years. But Meitu’s phone sales proved to be just as ephemeral as the beauty it helped its users create, prompting the company to discontinue that business and switch its focus to advertising services.

The company also sells VIP subscriptions that provide advanced features on its apps and remove advertisements. These became Meitu’s largest revenue source in the first half of 2022, logging 61% year-on-year sales growth, as online advertising revenue took a hit when companies cut their marketing budgets during last year’s Covid flare-ups that led to major business disruptions.

Meitu also offers software-as-a-service (SaaS) products to business customers, such as a supply chain management system for cosmetic retailers and a skin analysis tool using artificial intelligence for medical aesthetic institutes and beauty spas.

So, the company has become a lot more than just a gimmicky app maker. But it’s one thing to have a diversified product lineup, and quite another to be profitable. For starters, its revenue growth looks mediocre for a technology company, and has been bumpy as it constantly shifts its business mix. In 2021, Meitu posted 40% revenue growth, which isn’t bad but also isn’t spectacular. And the pace slowed sharply to a little more than 20% in the first half of last year.

Perhaps the most troubling part of Meitu’s latest results was the drop in its gross margin to about 52% from 66% in the first half of 2021, despite its focus on the high-margin software businesses. That means the company incurred substantially higher costs to generate sales. As a result, its gross profit actually declined in the first half of last year. And with other expenses and impairment losses on cryptocurrency holdings added, Meitu’s net loss more than doubled for the period. Even on the adjusted basis, its net profit also grew just 8%.

Meitu stock trades at a price to sales (P/S) ratio of about 3, a modest multiple for a technology company. Because the company does many things, it’s tricky to find direct peers for comparison. But given its growing focus on the SaaS business, a comparison with companies in that sector can help to put its valuation in perspective. For example, e-commerce SaaS provider Weimob (2013.HK) currently trades at a P/S ratio of about 5.6, while the figure for real estate-focused SaaS company Ming Yuan Cloud (0909.HK) is even higher, at 6.9.

Meitu’s current valuation shows that investors don’t see too much of the beauty that is part of its name in the company’s prospects. That probably won’t change until it delivers an actual profit without the need to filter out elements it considers unnecessary.

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