Profitability Analysis of a Game Streaming Business

Photo by Florian Olivo on Unsplash

Disclaimer: This post is purely based on my opinions, knowledge of business models and my own personal investment experiences. The writer holds no responsibility for any loss caused by any investment decision arising from this article.

To me, the first step to investing is always about understanding the business model. The idea is to fully understand the sources of its revenues and costs. Business model analysis is imperative to determining profitability and sustainability of a company.

Steps to Business Analysis

Four-phase process for business model analysis:

1. Profit Tree Model
2. Customer Journey Map/Service Blueprint
3. Who, What, How Analysis
4. Analysis of indicators of business operating environment

For this article, I will only share on one concept which is the Profit Tree Model. I talk about the other three concepts in the future.

Profit Tree Analysis

To understand revenues and costs structures, I applied the framework of profit tree to Huya, a game streaming company in China. Profit tree is a framework that is used by consulting firms to quickly diagnose situations, explore business and come up with profit growth strategies. It consists of several layers as shown in Fig 1 below.

Fig 1, Profit Tree Model of Huya

It starts with the profit node, then branches out to revenues and costs nodes in the second layer and to each individual nodes in the third layer. Each node in the third layer sums up to the revenues and costs in the second layer.

To elaborate on the revenues & costs segment:

In short, profit is a function of summation of components in revenues and costs. In order to be profitability, the summation of revenue’s branches has to be higher than cost’s branches.

How does Huya works?

I shall briefly explain on how the Huya game streaming platform works, it is a platform that can be accessed via website or App on mobile devices. Being a multisided platform, it brings together two or more interdependent groups of users and in this case, they are the broadcasters and viewers.

Broadcasters are people who comment on the games to bring about interaction with the viewers and viewers can comment on the games as shown in the white wordings on the screen in Fig 2.

Fig 2, An example of a live stream from https://www.huya.com/

Revenues

Huya is very accessible to the masses as a registered account is not needed to watch the games. Basically, anyone can open the website or App and watch a game right away. However, a registered account is required in order to send virtual gifts to broadcasters. Huya generates cash from these virtual gifts and they split the revenue with the broadcasters. From Fig 1, we can see that 95% of the revenue comes from members sending virtual gifts to the game broadcasters.

Hence, in order to profitable, they need to leverage on this gifting function in the platform and continue to innovate on the gifts and special features for “noble” members to decrease the churn rate (number of members unsubscribing from membership) and increase the membership take-up rate.

Costs

Let’s analyze the trend of operating costs for the company in Fig 3.

Fig 3, Trend of increment of cost as compared to the year before

From Fig 3, we observe that R&D cost seems to be increasing and it’s a good thing as innovation brings about improvement in business. What we want to compare now is the sales & marketing cost with respect to a quantifiable measure, which is the Monthly Active User (MAU). This will give us a rough sense of whether the increase in marketing cost raise the viewership rate and in turn increase the revenue from the live streaming segment.

Fig 4, Combo chart showing quarterly MAU, expenses and revenue

On the left axis of Fig 4, we see the quarterly average MAU and total number of paying users. On the right axis, we can measure the sales & marketing expense, total revenue, revenue from live streaming.

Table 1, YoY increase in R&D, Sales & Marketing and G&A costs as illustrated in Fig 3

We can see that there is increase in sales and marketing costs in Table 1 where it increased by 27% from 2016 to 2017, increased by 117% in 2018 and 132% in 2019. This is accompanied with an increased and consistent volume (from returning customers) of paying users and MAU as shown in Fig 4. This is also translated to higher revenues both in terms of total and live streaming segment. The increase in sales & marketing cost is steep, but since the user base is on an increasing trend, we can assume that there is return of investment from spending on advertising for Huya’s platform.

On a side note, Huya thrives on network effect. Network effect is when a service gains additional value as more people uses it. Additional entertainment content is created when there is real-time interactions between viewers and broadcasters or even among viewers when they communicate with one another during the game. With increased user base, there will be more entertainment content being created by the comments from the users during the games.

Profit Analysis

Let us now analyze the profitability of Huya…

Mathematically, profit is equivalent to revenue minus cost. Let’s look at a snippet of Huya’s financial statement below in Table 2.

Table 2, Revenue, Net Operating Income and Operating Margin table (in thousands)

We use the revenue and the net operating income (revenue less operating expenses) to calculate the operating margin by taking the net operating income as a percentage of the revenue. The operating margin will allow us to know the how much money Huya is making from its operations as a proportion of its revenue.

The operating margin increases from 2017 to 2019 and the bulk of the costs comes from R&D and Sales & Marketing, both of which will improve the business of the company in the long run through innovation and by building its brand awareness respectively.

Conclusion

• 95% of Huya’s revenue comes from live streaming which includes sending virtual gifts to broadcasters and conversion to “Noble” account users.
• Huya’s Sales & Marketing costs increased by 27% from 2016 to 2017, increased by 117% in 2018 and 132% in 2019.
• Huya’s operating margin is very low, however it is increasing gradually. This is a positive sign as the company is now turning profitable.

Huya is a relatively young company that was started in 2016, hence it is normal to have high costs structure as they needed to do extensive marketing to establish its brand name. As a result, Huya became the market leader in the game streaming industry, especially after its merger with rival company Douyu. Both Huya and Douyu own 80% of the market share in the game streaming industry in China.

With the merger with rival company Douyu and increased stakes of Tencent in Huya, the company no longer need to market aggressively as it has “acquired” all the customers from its rival. With the decreased competition and increased brand awareness due to the effect of being the supplier with the largest market share in the market, the sales & marketing costs may reduce drastically in the future.

Hence, I believe that there is potential in Huya to continue to be profitability in the future.

Thanks for reading!