Counterfeit goods have long caused problems for China’s e-commerce goliaths. Now fake users may be the issue for Chinese video streaming company, YY Live, according to allegations by short-seller Muddy Waters. YY Live is controlled by Nasdaq-listed Joyy. These charges have wider implications.
Muddy Waters’ founder Carson Block says in a 71-page report that the YY Live platform is 90% fraudulent, stating that its paying fans are fake users. Moreover, Block alleges the platform's users have not earned the revenue that Joyy says they have.
Massive losses and negative cashflow are common in emerging markets e-commerce and, in the face of poor traditional financial metrics, such as earnings growth and cash generation, companies focus on non-financial metrics instead, such as user numbers. The tech boom has been built on such non-financial metrics, and this is especially the case in emerging markets.
For example, Sea Limited has become ASEAN’s largest company, having risen four-fold in 2020. Even though it is loss-making and is unlikely to be cashflow positive for many quarters, the stock keeps rising because of improvements in non-financial metrics. In its quarterly results, the market focuses on line items such as number of users and hours of usage.
The trouble with non-financial data points is that they are even more susceptible to manipulation than financial ones. There is no independent auditor for gross merchanise value (GMV) and user metrics – they are self-reported and prone to abuse.
The scrutiny of emerging markets tech firms and how they report could increase if these Joyy allegations prove to be correct, and there could yet be other skeletons in the EM tech cupboard. The Joyy scandal could be a step on the path of shattering the illusion of non-financial metrics, which in turn could finally burst the tech bubble. And perhaps the manipulation of non-financial metrics will be the prelude for abuse of financial metrics.
Grim news for the Baby Amazons
Of course, fake users not only found in emerging markets. Facebook estimates that duplicate accounts are 11% of its monthly active users. Fake accounts are another 5%. If you deduct these numbers, user growth is lower.
However, in the EM e-commerce (Baby Amazons) category, there is a very clear tendency for investors to trade stock on non-financial metrics.
As the chart below shows,tThe Baby Amazon asset class has risen sharply in 2020...
...But this outperformance has been driven by non-financial metrics, such as GMV and users, as opposed to EBITDA. LatAm's MercadoLibre Inc. is the sole exception.
The Joyy controversy suggests that the methodology for generating these non-financial metrics could well come under greater scrutiny. The pressure on the Baby Amazons to produce cash would then be even greater.
We urge investors to favor Baby Amazons that are better valued – JMIA US and BABA US — versus the elevated counters like SE US.