Stock update: Autohome Inc

Stock update: 14th August 2017

We have exited our position in Chinese online automotive classifieds business Autohome Inc. after our investment thesis materialised in recent quarters, realising a significant gain on sale. We made our initial investment during the first quarter of 2016 and added to it as the year progressed.

For those unfamiliar with the original investment thesis, below is a brief recap.

What created the Autohome share price anomaly?

  • Decision by management (now previous management) to enter the capital intensive direct automotive sales business. The economics of this business – essentially a glorified online car dealership – were inferior to that of the asset light lead generation and media businesses Autohome had historically focused on. This decision lead to substantially lower margins and diminished returns.

  • Broader concerns around economic growth in China. Fears for a ‘hard landing’.

  • Uncertainty around a change in controlling shareholder from Telstra to Ping An Group, China’s largest private insurance company.

Consequently, Autohome’s share price declined over 60% from its peak in 2015 and valuations fell to below 15x forward earnings despite 20%+ year-over-year revenue growth in the core lead generation and media businesses.

Autohome Inc
Source: Autohome Inc - Quarterly Results, Factset.

What did we like about the business at entry?

  • Clear market leadership in the online automotive classifieds category in mainland China. On our estimates Autohome generated 50% more leads to dealers than its nearest rival. Given the superior product offering and the importance of network effects on the online classifieds business model we considered Autohome to have a strong moat around their market position.

  • Significant value in the lead generation and media businesses being masked by the decision to enter the direct sales business. We remained confident that these capital light businesses would continue to generate significant free cash flow overtime and engaged management to reconsider the direct sales business so that capital would not be deployed to expand into inferior business areas.

  • Long term structural growth of the automotive advertising category and the transition to online advertising for both dealers and automotive manufacturers. We believed this would continue to play out despite concerns around China’s broader economic growth.

  • New controlling shareholder with an active role in management.

  • Significant cash on the balance sheet.

What has transpired since we made our investment?

  • On arrival Ping An Group’s management team underwent a strategic review that specifically looked at the decision to enter the direct sales business. In November, it was confirmed that Autohome would exit this business.

  • Meaningful margin recovery as the direct sales business was wound down in Q4/16 and Q1/17. This drove a significant increase in the markets forward earnings estimates.

  • With the decision to exit the direct sales business confirmed investors refocused their attention on core lead generation and media businesses where growth remained robust despite a slowing Chinese economy.

  • Management raised the prospects of capital management initiatives aimed at addressing the significant accretion of excess capital on the balance sheet.

  • Concerns about a ‘hard landing’ in China subsided.

Despite continuing to view the business and management favourably, developments over the past 12 months have resulted in a substantial increase in earnings expectations and valuation. Consequently, we took the opportunity to realise the investment.

 

Stock update: 10th February 2017

Kevin Bertoli, Portfolio Manager of the PM Capital Asian Companies Fund and the PM Capital Asian Opportunities Fund (ASX:PAF), explores the environment surrounding the holding in China’s answer to Carsales.com.au, Autohome.