Yalla In Transition As Gaming, Geographic Diversification Make Gains (NYSE:YALA)

New product and geographic expansions are making the Middle Eastern social media company more diversified, but are also squeezing its margins

We once compared Yalla Group Ltd. (NYSE:YALA) to the likes of voice-based social media pioneer Clubhouse and later the more mainstream Facebook (META), based on the company’s early focus on voice technology and its more recent foray into the metaverse.

But these days, big gaming companies like Tencent (OTCPK:TCEHY) and Activation Blizzard (ATVI) might be better comparisons for this Middle Eastern-based social media company focused on developing markets. That’s because games are rapidly growing in its business mix, and if current trends continue, could overtake the company’s older voice services as its biggest revenue source.

The company also differs significantly from Facebook and other social media companies like Twitter and Weibo (WB), which rely heavily on advertisers for their revenue. Instead, Yalla is like the gamers in earning most of its money from user spending – another trend that also appeared to be accelerating in the company’s latest results released on Monday.

Like many companies in the fast-changing social media realm, Yalla is in a bit of a transition these days. It began as a voice specialist, and saw that part of its business grow explosively through last year. Then that business began to mature, even posting a year-on-year decline at the start of this year, before returning to single-digit growth. As that business slows, Yalla has turned to other areas, both geographically and in terms of product mix, to transform to a better-rounded company that can return to the strong double- and even triple-digit growth of its first few years.

But such efforts take money and time, both for product development and opening of facilities in new markets. That, in turn, is pressuring Yalla’s margins in the present, since most such initiatives will take at least a year or two to start bearing fruit in terms of meaningful revenue.

All that brings us back to the present, where Yalla’s latest quarterly results looked generally solid even if they were far more muted than the kinds of explosive growth that wowed investors in earlier days after its 2020 New York IPO. Reflecting that, the company’s stock was pretty much unchanged in Tuesday trade after the results came out, falling by a slight 0.2%, though it fell by a larger amount the next day in a broader market sell-off.

The company’s shares are down 34% so far this year, though they have also rallied by 32% from a mid-October low as its situation stabilizes and shows signs of improving. At that level, it currently commands a price-to-earnings (P/E) ratio of 8.7. While that may not look that exciting, it’s actually roughly in line with a 9.8 for Facebook parent Meta, and a 10.8 for Weibo.

The company’s overall revenue grew 12.3% in the third quarter to a record $80.1 million, which was similar to the growth rate the previous quarter and well ahead of the company’s earlier guidance. Yalla added its revenue would continue growing at similar high-single to low double-digit rates in the current quarter, and analysts polled by Yahoo Finance forecast similar growth next year.

Gaming star

While overall revenue growth was solid but not spectacular, the company’s gaming business performed much better and is quickly becoming Yalla’s main growth driver. Gaming revenue rose 37% year-on-year – roughly triple the overall revenue growth rate – to $23.9 million for the quarter. At that level it now accounts for 30% of Yalla’s total revenue pie, up from 24% a year earlier.

By comparison, its older voice services – which account for the remaining 70% of revenue – grew by a more modest 4.3% in the latest quarter year-on-year.

Recognizing the importance of games to its revenue mix, Yalla previously announced it was expanding beyond its original focus on casual gaming to more hard-core games. On that front, it revealed it rolled out a beta version for its first hard-core game “Merge Kingdom” in the third quarter and plans to launch a second hard-core game by the end of this year. It also provided updates on new features and tweaks in Waha, its metaverse product launched earlier this year.

By diversifying its product mix with games and other functions like instant messaging on a more unified platform, the company has been able to milk more money from its users – a key challenge for social media firms that can often boast huge user numbers but have much more difficulty getting money from those users.

While the company’s monthly average user (MAU) base rose 19.1% during the quarter to 30.9 million, its base of paying users rose by a much quicker 50.3% to 11.5 million, showing it is having more success getting users to pay to play, so to speak.

Based in the United Arab Emirates with a major product development center in the Chinese city of Hangzhou, Yalla is trying to parlay its success among Middle Eastern users into other developing markets, with ongoing efforts in Latin America and Turkey. It signaled the Latin American drive was gaining momentum, noting its Yalla Parchis app ranked in the top five in revenue terms for the board game category in 10 Spanish-speaking countries in the third quarter, up from six countries in the previous quarter.

But as we noted earlier, most of the diversification efforts, both into new product types and geographic areas, are still in their early days and have yet to make major revenue contributions despite requiring big investment. As a result, the company’s cost of revenues and R&D costs grew significantly faster than its actual revenue in the third quarter, causing its net margin to drop to 30.5% for the period from 35.5% a year earlier.

That squeezed the company’s third-quarter profits, which fell 3.6% to $24.4 million year-on-year on a GAAP basis, and were down 11% to $29.4 million on a non-GAAP basis.

At the end of the day, Yalla is clearly a company in transition, both geographically and in terms of product mix. It has a relatively solid base in the Middle East, and is expanding from its traditional focus on voice-based social media into games and text- and graphics-based communications, as well as moving into other developing markets. But the company will need to show some returns from those investments in the form of stronger double-digit growth before it’s likely to wow investors again like it did shortly after its 2020 IPO.

Disclosure: None.

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