Sungy Mobile Collapse Confirmed in 2Q '14

WWW.TRINITYRESEARCHGROUP.COM 8/28/14

Sungy Mobile Collapse Confirmed in 2Q 14

SUNGY MOBILE 2Q 14 EARNINGS PREVIEW: GOMO A NO-GO AUGUST 28, 2014

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EXECUTIVE SUMMARY

As we expected, GOMO reported the companys worst quarter ever yesterday, whiffing on every metric.

CFO Winston Lis unexplained and sudden departure marks the third finance exec and the seventh exec overall to bail in under two years.

Clear signs of a reversal from growth to decline featured a first-ever decline in MAUs, among other signs. GOMOs core is officially shrinking now.

Clear signs of a pending collapse included contracting margins, failed monetization efforts and step function hit to cash cow reading/literature business, among other signs.

Management defections, weak disclosures and an inexplicable discrepancy between third-party data and reported numbers make us even more suspicious than before of overstated metrics.

Sungy Mobile (Nasdaq:GOMO) reported 2Q 14 earnings yesterday and it was, in a word, UGLY. Where to begin. CFO BAILS How about with the announcement that was buried deeply in the press release under one of the later subsections, Management Changes? GOMOs clear intention was to de-emphasize what was one of the biggest news items of the quarter. CFO Winston Li apparently had enough and bailed. From the looks of it, his departure was probably not amicable, since he could not even wait until after the earnings call to bail. CFOs leave here and there, so that is not particularly newsworthy by itself. But at GOMO, Lis departure is notable because he is now the third senior finance exec in the past year or so who has bailed, the other two being the prior CFO Yang Shuqin, who left GOMO at the altar just two months before the IPO (after a whopping four-month tenure!) and Audit Committee Chair and director of GOMOs board Jonathan Zhang who left the company six months after the IPO. What do these three senior-most finance execs at GOMO know that investors do not, and why are they leaving inexplicably and silently? And lest we forget, Lis departure marks the seventh executive departure from GOMO without even including the exodus of talent at recently acquired GetJar in California. See our prior report1 for a detailed list. 1 http://trinityresearchgroup.com/wordpress/?p=1


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REVERSAL OF GROWTH TO DECLINE It was a sad day. Growth in monthly active users (MAUs), the metric that GOMO touted the hardest as most indicative of their potential and global appeal, is officially over. MAUs had been growing from 34 million in 1Q 12 to 100 million in 1Q 14 but took a dive to 96 million in 2Q14 for the first time ever. What made this more notable is the strength of other mobile products that operate a freemium model this past quarter. Notably, Cheetah Mobile (CMCM) crushed their earnings expectations, and throughout the world, the most popular apps are growing strongly. Whatsapp, for example, turned in its 600 millionth user recently.2 Meanwhile, GOMO declined. What makes matters worse is that MAUs declined while marketing went up quarter on quarter. PENDING COLLAPSE So what happens when you spend more to attract an audience and your audience contracts anyway? Something you call margin contraction. To the tune of a 20% fall in operating margins excluding recently acquired GetJar. But wait, it gets worse. GOMO has been touting its low monetization as a huge long-term opportunity. The idea is that you cant grow forever, so when youre growing you focus on growth and then when youre slowing, you focus on monetizing the massive user base youve supposedly built. Is that what happened? In a word, no. Not only did growth slow while marketing went up (in other words, the company was paying to grow but contracted in users instead), the companys alleged focus on monetization appears to a culprit: per management, focus on monetization hurt user experience, which is why MAUs declined. So they are now working on user experience. Obvious rhetorical question: if they fix that, what happens to monetization? This quarter seriously puts into question whether GOMOs sizable user base is economically valuable at all beyond the very low rate theyve already monetized, because so far the answer is a resounding no. It gets worse still. The company also experienced margin contraction because they spent more on R&D. So its not just that they slowed, and they slowed while trying to grow and trying to monetize but failing at both. They also invested in new product development to try to come up with new channels for growth but failed. Brutal. Can it get worse? In a word, yes. Because another way to grow is to buy a company thats growing. Inorganic growth. If you cant grow organically, you might as well try to grow inorganically, right? In 2 http://www.thestreet.com/story/12855144/1/how-whatsapp-will-help-make-facebook-money.html


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GOMOs case, wrong. Just a few months ago, on February 12, GOMO announced the acquisition of GetJar3, an alleged high-growth company that would allow GOMO entry into advertising. How did that work out? Read the section on GetJar from our prior report to get a sense of whats going on there. A total disaster. Can it get even worse? THE HIT FROM PORN Yes, it can. In our prior report, we discussed our finding that Chinas anti-porn crackdown had impacted many companies, some being completely shut down and others being served stiff correction notices. We also discussed our recent interview with GOMOs largest distributor for the reading/literature product, none other than Chinas dominant mobile carrier China Mobile. Apparently, China Mobile banned GOMOs reading/literature product because they found most of the paying users were in fact paying for porn. Let us just say we were not surprised to find this on the 2Q press release:

Revenues from mobile reading services was RMB18.0 million (US$2.9 million) in the second quarter of 2014, down from RMB24.9 million in the prior year period, primarily due to fewer purchases of the Company's online literary content.

A near 30% drop in revenue for a previously growing business that used to make up about a third of total revenues for GOMO! Why could this be? From the press release, not a peep. But if you listened carefully on the earnings call, the management team referred to a change in government policy as the reason. Could government be state-owned enterprise China Mobile and could the change refer to the governments stance on all things pornographic? We will let you decide for yourself, because there is no shortage of interesting questions to consider. SOME QUESTIONS THE SELL SIDE FORGOT TO ASK The call could have been six hours long because there are so many unanswered questions.

Why did Winston Li bail so suddenly? What is going on with GetJar? Why no update at all? How has that investment worked

out so far? Speaking of investment, all that extra R&D spend has produced exactly what?

3 http://ir.sungymobile.com/phoenix.zhtml?c=252388&p=irol-newsArticle&id=1899375


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If MAUs declined because you tried to improve monetization and ruined the user experience to the pint that you are admitting you will fix it, what happens to monetization if you fix it?

Despite the fact that you had such a bad experience acquiring GetJar, are you really going to continue to do acquisitions? You acquired three mobile gaming companies in the last quarter. And yet you reported a paltry 3.6 million RMB of revenue (thats a little over half a mil in USD). What exactly did you acquire and how is that working out?

How can you put up a quarter like this one and have zero plan to talk to investors about other than investing in marketing and R&D some more? Wasnt that a bad idea in 1H 14, so why is that a good idea in the second half?

Heres a doozy: If your MAUs are declining and your paid subs are flat, as you reported, how can mobile app revenue be sequentially up?

And there are so many more. But perhaps the sell side just threw in the towel instead of asking tough questions. Citi analysts Thomas Chong and Ravi Sarathy appear to have done so, since they are the first to publish after the earnings call and they delivered a double downgrade from Buy (previous rating) to Sell (new rating) after they saw the numbers. Downgrade to Sell Greater Visibility on Outlook Requred, proclaims the Citi report published this morning. We wonder what the other four sell side firms that cover GOMO will say tomorrow. CONCLUSION GOMO was built on a house of cards. The idea that they could offer a bunch of commoditized mobile apps like launchers and screen lockers and battery optimizers and conquer the world was a fantasy at best. In practice, it worked OK for about a year before competition ran rampant and took share by the millions of MAUs. Now that the growth has reversed, the party is over, and you have a commoditized declining user business whose market cap was built on user growth on the hopes of monetization that never came. You have declining MAUs, failed monetization efforts, ineffective marketing spend, contracting margins, failed acquisitions and porn. The margin hit from porn, which is incredibly profitable, is permanent. In other words, GOMO now has structurally much lower margins on top of everything else. But perhaps the most worrisome issue with GOMO is the team. We simply cannot ignore the mass exodus of senior execs, especially finance execs, over the past year and a half, and we simply cannot ignore how the numbers just dont make any sense in spite of the hard third-party evidence we presented in our last report, and we simply cannot ignore the fact that the management team has very poor disclosure of major issues like CFO departures and porn, the first of which was buried deep in a press release on the day of earnings (talk about blind-siding investors) and the second of which the management will not even address head on, using words


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like fewer purchases of literary content due to change in government policy instead of admitting they are now reformed pornographers running a much worse business.

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Sungy Mobile Collapse Confirmed in 2Q '14