BILI 2022 Q2: Darkest Hour or Cage Match? [2/2]

 Why cling to ads?

As discussed in the last article, Bilibili’s main problem is to find a way to transfer its impressive community to actual profitability. According to the report, An Atypical Guide to Marketing on Bilibili from TBWA/BOLT, OMG and OMD, about 58% of post-90s and post-00s visit Bilibili at least once per month. However, Bilibili's desire for monetizing digital content seems not strong. Some people in the EqualOcean team are loyal users of the website, and they found that most users in the fan community mode have formed the habit of not paying (Chinese: "白嫖", "下次一定"). However, the problem came that, in 2022Q2, the ARPU value paid by users decreased by 16% compared with the same period last year, and the year-on-year growth of Bilibili MPU continued to slow down since the beginning of 2020. The platform has operated at a loss since listing on the Nasdaq in 2018, and it is increasingly unlikely that Bilibili will turn the loss into profit in 2024, as it always asserts.

No one could deny the profit model is the essence of the business model. We do believe Bilibili should get rid of the current low-gross-profit mode but rely on advertising to make profits. As we all know, there are two major benefits of becoming g premium member of a content platform: ad-free access and premium exclusive content. Till now, Bilibili only provides the second benefit, which directly affects the growth rate of advertising revenue. As a result, the more uploaders' non-profit videos are made and played, the more bandwidth load the platform will burden. After the model game business of Bilibili shows sluggish growth, the promise of never using pre-roll ads seems to have been unable to be realized logically, especially after the Q2 2022 performance was released. Therefore, we believe that if the cutdowns do not help the financials of H2 2022 much, Bilibili will be more aggressive in the layout ads business.

A unique way for ads

Nevertheless, how penetrating the advertising business wisely is a challenge for all content-based platforms, especially Bilibili, which values its community the most.

The management of Bilibili said in the second quarter of the research call that the macroeconomy has a very negative impact on advertising in the short term and is expected to last for 1-2 years. However, Chen Rui, CEO of the Group, is optimistic that Story Mode will become the key to a breakthrough. We think this is a signal that a large number of advertisements may be added to this mode, and the proportion of Store Mode pushed on the homepage will be increased, even adding a channel just for the story mood videos (like the Shorts mode of YouTube).

However, in traditional landscape mode, we are more willing to believe that Bilibili will maintain its current no-pre-roll-ads status. Nevertheless, we think Bilibili will eventually build a system to connect uploaders and advertisers and may give guidance about how to integrate the ads into the original content more smoothly and interestingly. In such a way, uploaders have more exposure to sponsors while maintaining their freedom of creation. Bilibili, in such a way, could also take part in the commissions as revenue. We believe content-integrated ads are a sustainable mode, especially will be approved by advertisers because this kind of ad adds enable them to measure the quality of their advertising. It can clearly know the attractiveness of its advertisements through the number of fast-forwarding and bullet screen comments (Similar to but different from YouTube TrueView logic) and can make adjustments according to the data gathered. Similarly, the 'fake video' ads in the Story Mode also have this effect (measuring the time that the user jumps to the next). Therefore, when considering cooperation with uploaders, advertisers need to consider making the brand part of the content.

In contrast, its domestic competitors' non-skippable pre-roll ads can only collect user information instead of knowing what's the effect of the ads, which may affect the real efficiency of advertisers. That's why we think Bilibili has great potential in the ads business.

After all, Bilibili (including its uploaders) does not resist all kinds of ads but opposes mindless and shouting ones. In other words, maintaining the community and viewing experience is the top priority for all the stakeholders.

New Stories to tell (Catalysts)

Besides the short-term and long-term solutions, we also found three catalysts that may help Bilibili out of the profitability distress.

First, deepening cooperation with luxury brands has an overall influence on the platform. According to the report published by BCG and Tencent, A new generation of Chinese consumers remapping the luxury market in 2021, the Chinese luxury consumers are iterating, and the post-90s account for over half of the total luxury consumers in China. 25% of the new consumers are post-95s, and more than half of the annual consumption exceeds CNY 50k in this space. This, we analyzed, also means that joining Bilibili will be regarded by young people as a positive signal that the traditional luxury brands want to change. Some luxury brands such as Louis Vuitton and Fendi have carried out advertising campaigns on Bilibili. Some brands such as Dior, Givenchy and LANVIN, as well as some luxury vehicle brands such as BMW, even operate enterprise accounts. Moreover, in the process of developing innovative ads business, luxury brands may become better partners.

Second, the group is integrating the comics resource it has or can acquire and temporarily form an oligopoly market. In 2019, Bilibili Comics launched Bilibili Comics and acquired Netease Comics right after that. In November 2021, Bilibili wholly acquired the original comics platform of Aofei Entertainment, You Yaoqi. In March 2022, Bilibili acquired Baizhi Animation. Chinese comics website U17 announced to be folded into Bilibili by year's end 2022. Through these acquisitions, Bilibili has greatly increased its own copyright database, and the Chinese comics market has formed a tripartite trend of Tencent Animation, Bilibili Comics and Quick Look Cartoon. We noticed that Bilibili has applied for a number of bullet screen-related patents. Among them the patent for comics-based bullet screen display method and the device (CN114897668). This proves the company's future attention to the comics business.

Finally, more creative content types such as metaverse content may bring extra cash flow. On August 27, Chen Rui, CEO of Bilibili, predicted that as a comprehensive industry, the metaverse would be the most important digital content area in the future. The world in the metaverse will be a content ecosystem, where massive content cannot be provided by several companies, and UGC content will become the mainstream of the metaverse. Users in the metaverse are both consumers and producers, which is highly in line with the mission of Bilibili. We think this is an important opportunity for Bilibili

Similarly, the issuance of digital collections may also bring some relief to the stressed Bilibili. On August 2022, the Shanghai Data Exchange (SDE) launched the first official exchange place in China for the trading of digital assets, creating in-depth integration between digital assets and the real economy. Huili DESIGN – Yuannian is the first digital asset to make its debut on the SDE Digital Assets Board, which is jointly issued by Bilibili. We think NFT could be regarded as a blue ocean in the Chinese market, and Bilibili is trying to be a gold digger.

Bottom Line and Valuation

Even though Bilibili's multiple is at a historical level, there is value trap risks exit. Based on the discussion above, we downgrade the stock to an underperform rating. We always believe that, for Bilibili, the conflict between community and commercialization has reached a situation that must be resolved. Now what the management should do is find a balance point and take measures immediately. Bilibili is still betting that the positive profit income brought by its broken circle can improve the profit structure, but it is undoubtedly driving on a long and arduous road. In this process. As we said, it may be an effective strategy to reduce costs in the short term, innovate the advertising business in the long term, and pay attention to three main growth catalysts (Luxury, Comic, and NFT) at the same time.