Yalla Group (YALA) registered year-on-year revenue growth, maintained enviable margins, and saw continued growth in paying users during the first quarter. However, the company is gearing itself towards a second growth phase. R&D spending on self-developed products in the gaming sector, has increased, while the firm continues to explore collaborative opportunities.
 

Image Source: Yalla.com

Introduction

Yalla Group is a MENA-based online social networking and gaming company. The firm experienced lightning-fast growth during the pandemic, but as with many companies, it's found it hard to sustain that extraordinary level of growth in the post-pandemic world.

Yalla is now gearing itself towards a renewed push into the gaming market. The company already has several offerings in the casual gaming sector but has recently launched itself into the mid-and-hard-core gaming business - Age of Legends (MMORPG) is among its latest products. It's in this context that Yalla reported its Q1 results.

The company's results show that, in the three months to the end of March, revenue increased by 1.6%, to US$73.5 million, versus the first quarter of 2022. However, Q1 revenue actually came in lower than the US$75.1 million achieved in Q4 of 2022.

It's clear that in the current environment, characterized by the end of Covid restrictions in most places around the world, and amid increasing competition, growing business is a more challenging proposition than it was two years ago. The stock was trading around US$3.90 after the Q1 announcement.

Despite this, I believe the company is well positioned for a second growth phase, powered on by its move into mid-and-hard-core gaming, and the current share price represents an attractive entry point.

Let's take a closer look at this MENA-focused online social networking and gaming company and its Q1 results.

Q1 highlights

Some analysts may be disappointed with the slowing pace of growth at Yalla. As noted, revenues came in at US$73.5 million for Q1 of 2023, representing an increase of 1.6% from the first quarter of 2022, but a 2.1% decrease from the last quarter. This QoQ decrease could, partially, be attributed to nine days of Ramadan falling within the reporting period from January to March.

Meanwhile, net income came in US$19.9 million, versus US$17.7 million in the first quarter of 2022 and US$16.6 million in the fourth quarter of 2022. In this case, we can observe that net income grew QoQ as a result of falling costs during the three months. Total costs and expenses amounted to US$56.8 million in the first quarter of 2023, compared with US$54.1 million a year previous and US$60.1 million in the fourth quarter of 2022.

Monthly active users tipped upwards to 33 million, up from 32 million in Q4 of 2022. The growth in paying users is particularly encouraging. The group now has more than 13.5 million paying users, that's up from 9.4 million a year ago and 12.4 million in the previous quarter.

Net margins remain stable at 27.1%, up 12.4 percentage points year-over-year, down from over 40% in consecutive quarters of 2021. Falling margins are never enticing for investors, but in this case, it reflects ongoing R&D costs. Further margin compression appears unlikely based on management commentary.

A strong platform for growth

Recent results might not be groundbreaking, but I believe the company is in an excellent position to launch the next stage of its development. Yalla has been profit-making since its IPO in September 2020 – when it was priced at US$7.50 per ADS (American depositary share).

It's worth highlighting that as of March 31, 2023, Yalla had cash and cash equivalents of US$435.6 million. That's up from US$407.3 million as of December 31, 2022. This is a really significant amount of capital to drive the company forward, especially when we consider the market cap still sits around US$600 million. As an aside, with interest rates rising, Yalla earned US$3.1 million in interest income in the first quarter of 2023, compared with just US$0.05 million last year.

Very few companies are afforded such a cash-rich position so early in their development. But equally, I'm glad to see Yalla hasn't followed an aggressive growth or acquisition strategy. The focus on self-developed apps and collaborative projects won't come at the expense of the company's strong financial position.

Where next?

On Monday evening, Yalla management indicated the company's direction in the coming months. Key takeaways included:

• Little change with the monetization strategies of flagship applications, Yalla and Yalla Ludo. The company will continue to work on new iterations.
• R&D and G&A expenses will be maintained at a relatively stable level unless new investment initiatives are found.
• Yalla indicated a willingness to market its hardcore games offering to its existing community, as well as purchasing traffic from external channels.
• Revenue generation from mid-and-hardcore gaming may take time. The investment period may last for three months to several months, without significant revenue growth, management said.

My take

Yalla has an enterprise value just short of US$170 million. That's not a lot for a company that will likely generate between US$70-80 million this year – net income in 2022 came in at US$79 million and $82.6 million in 2021. Currently, it has an EV / EBITDA of 1.79, considerably below the sector average of 9.89 according to Seeking Alpha.

But there's a narrative that Yalla's growth is slowing and it's a struggle even just to stay still. And that's had a profound impact on the share price. It's worth remembering that Yalla traded for around US$40 per share at the height of the pandemic.

Moving forward, the company needs to identify the right opportunities to grow the business. And, so far, I like the way Yalla is going about achieving its objectives. It hasn't thrown good money after bad, instead it's focusing on developing existing applications and launching new ones without compromising the company's profitability in the short term.

With the stock trading below US$4, it's a buy for me. Revenue growth has slowed in recent quarters, but user figures have continued expanding even outside the pandemic. I think this demonstrates the ongoing attractiveness of Yalla's platforms, and that's particularly important if the company is going to ward off new competition.

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