Qutoutiao’s Reverse Share Split Spooks Wall Street

Key takeaways:

• Money-losing Qutoutiao has announced a reverse 10-for-1 share split to bring its stock back above the $1 level required by the Nasdaq
• Move sparked a major selloff of its shares as investors worried about a big loan coming due next April

By Doug Young

Throwing in the towel?

It’s probably too early to say that just yet about China’s rapidly fading No. 2 news aggregator Qutoutiao Inc.(NASDAQ: QTT). But investors seem to increasingly think a shutdown or fire sale of the company could well be in the cards, based on their reaction after Qutoutiao’s announcement late last week of a reverse stock split.

The move was fairly routine, aimed at bringing Qutoutiao’s American depositary shares (ADSs) back above the $1 level to put them in compliance with Nasdaq rules. While the company has been steadily shrinking in terms of market value this year, its current market cap of more than $100 million is still fairly large and should be sufficient for a continued listing.

The reverse split will see the company’s ADS ratio change from the current four ADSs to each Class A ordinary share, to a new ratio of two ADSs for every five Class A shares. That translates to a 10-for-1 reverse share split. Thus based on the ADS’s latest close of $0.3864, the new stock price would rise tenfold to $3.864 when the change becomes effective on Friday.

While all that sounds fairly routine, investors didn’t see it that way. The stock was trading at $0.60 before the announcement, meaning it has lost about 35% of its value over the last three trading days. That’s not exactly an encouraging sign from investors, which is what led to our opening remark that perhaps some are starting to expect an ending soon for the company.

In fact, such an ending doesn’t necessarily need to entail a shutting down of Qutoutiao entirely, but could instead involve a sale of the company – something we’ll discuss in more detail shortly.

Founded in 2016 and listed since 2018, Qutoutiao was once a rising star in China’s news app scene, securing its place as a solid but distant second to ByteDance-owned industry giant Jinri Toutiao by focusing on consumers in China’s smaller cities. But the company’s business model of spending heavily to acquire users has proven unsustainable, leaving Qutoutiao, whose name means “fun headlines,” to focus this year on customer retention over big growth in user numbers.

Adding to the company’s problems have been recent signals from Beijing that the government may be preparing to crack down on independent news companies. Such a move would have much-bigger consequences for Jinri Toutiao and major news portal operators like Sina, Sohu (NASDAQ: SOHU), NetEase (NASDAQ:NTES; 9999.HK) and Tencent(0700.HK). But it could also put smaller names like Qutoutiao in a difficult position.

The more immediate issue for Qutoutiao is a 1.2 billion yuan ($188 million) convertible loan coming due next April that the company has mentioned in its last two quarterly reports as posing a challenge. That loan is likely to be a subject for discussion again in its next report for the third quarter, which should be out in the next week or two.

“Given the significance of the loan, there is uncertainty regarding the company’s ability to repay the convertible loan upon maturity, which raises substantial doubt about the company’s ability to continue as a going concern,” it said in its second-quarter report back in September. That wording is quite standard when there’s a possibility a company believes it may have to cease operating.

Friend in Alibaba?

The loan behind Qutoutiao’s existential dilemma was provided by Alibaba (NYSE:BABA; 9988.HK) during better times for the company in March 2019. At the time, Alibaba saw the loan as a strategic move due to its option to convert the amount into about 11.4 million Qutoutiao ADSs at $15 apiece, equal to about 4% of the company.

Of course, conversion of the loan into Qutoutiao shares is now out of the question. But its still possible Alibaba could negotiate a deal to forgive the loan in exchange for most or all of Qutoutiao. That might explain Qutoutiao’s current market value, which at $111 million is close to, though still a bit smaller than, the amount of the loan.

One hitch to such a deal could be recent pressure on Alibaba to divest some or all of its media assets, which is coming from Beijing officials worried about the company’s big influence. That pressure reportedly has Alibaba looking to sell the Hong Kong-based South China Morning Post, one of Asia’s leading English-language newspapers, which Alibaba bought in 2015.

Against that kind of backdrop, an acquisition of Qutoutiao by Alibaba seems unlikely. Other buyers may also be hesitant to make such an acquisition due to the current uncertainty surrounding private news providers in China.

From a purely financial perspective, Qutoutiao’s situation actually looks relatively stable following its shift this year to a more-conservative spending strategy. The company had 400 million yuan in cash and cash equivalents and another 39 million yuan in restricted cash at the end of June, as well as 600 million in short-term investments – which collectively is close to the amount it would need to repay the loan.

In terms of its financial performance, most of the company’s key metrics are currently contracting as a result of the reduced spending on new user acquisition. Qutoutiao’s revenue began contracting in last year’s third quarter, and its most recent report showed the figure fell 16.6% year-on-year in this year’s second quarter to 1.2 billion yuan.

Its combined monthly average users (MAUs) slipped 3.1% year-on-year during the quarter to 132.3 million, while its daily average users dropped by a larger 32.3% to 29.1 million. As a result of the more-conservative spending, the company’s net loss for the second quarter actually narrowed slightly to 209.5 million yuan from a 222.1 million yuan loss a year earlier.

At this point, only a single analyst polled by Yahoo Finance follows the company. But that person is currently forecasting the company should finally record a profit next year. In this case it really does seem like the clock is ticking to reach that important milestone before the convertible loan comes due in April.

If it can do that, it’s still quite possible Qutoutiao could get new financing to repay the loan to continue as a standalone company. But a more preferred option would be a sale of the company, as it really does look like Qutoutiao is too small and operating in too uncertain an environment to survive long-term on its own.