Transformation Gobbles Up Smart Share Global's profits

Key Takeaways:

• Smart Share Global’s revenue plunged more than 50% in the first quarter, as revenue from its core charging services tumbled amid its business transformation
• The company is gradually shifting operational responsibilities for its network of Energy Monster power bank cabinets to third-party business partners

By Doug Young

Power bank operator Energy Monster lived up to its name on Monday, frightening investors who dumped its shares after seeing the company’s first-quarter financials. Those results showed a sharp acceleration in its pace of revenue declines during the quarter as the company undergoes an important transition to make itself more profitable over the longer term.

But in the shorter term, at least, that transition is looking a bit painful for Smart Share Global Ltd.(NASDAQ:EM), the official name of the company whose Energy Monster brand of cabinets filled with rentable smartphone chargers are a fixture in restaurants, shops and other retail venues throughout China.

The company’s stock plunged more than 20% on Monday morning after it announced its latest results, biting off nearly $40 million in market value, though it later pared those losses and closed down around 10%. Here, we should note that even after the Monday selloff, the stock is still up more than 70% so far this year, putting it at the forefront of a rally for U.S.-listed China stocks that has seen the iShares MSCI China ETF rise more than 20% from a low in late January.

So, in some ways the big selloff could simply represent some profit taking. But the drop also seems to reflect some worrisome trends in the company’s latest results as it makes its transition. Repeated references to softness in Chinese consumer spending didn’t help, with CFO Maria Xin describing consumption as “still a bit weak” in April and May.

Under its transition plan kicked off last year, Smart Share Global is de-emphasizing its original business model of directly owning and operating cabinets of smartphone chargers in favor of selling those cabinets to third-party operators, presumably the owners of the many shops where the cabinets are located. The company then collects fees for things like providing payment services, and also from the actual sale of cabinets and chargers to its partners.

“This transition from the direct model to network partner model in certain regions has incurred one-time costs, but it is a strategic move that would benefit the financial health for the company in long run,” said CEO Cai Guangyuan on the company’s earnings call.

Those one-time costs may have been a factor dropping Smart Share Global into the red during the first quarter, ending four consecutive quarters of profitability. Despite that, the company remained profitable for a fifth consecutive quarter on an adjusted basis, which typically excludes stock-based employee compensation.

Smart Share Global’s growing pains were nicely summed up by its top line revenue, which plunged 51.7% year-on-year to 397.2 million yuan. While the company blamed the transformation, which we’ll discuss in more detail shortly, we should also point out that the rate of decline marked a sharp acceleration from the 18.3% year-on-year revenue decline in the previous quarter.

Following the selloff, Smart Share Global’s stock currently trades at a price-to-earnings (P/E) ratio of 17. There aren’t too many comparable companies operating shared power banks. But shared-economy company Meituan (3690.HK), which operates one of China’s top bike-sharing services, commands a far higher P/E of 47. Home-sharing stock Airbnb (NASDAQ:ABNB) is a bit closer, trading at a ratio of 20.

Booming Hardware Sales

Smart Share Global’s transformation looks a lot like what happened in the hotel industry around the 1980s, when companies like Marriott (NASDAQ:MAR) and Hilton (NYSE:HLT) shed their property assets and transformed into managers of their namesake brand hotels for third-party property owners.

Such a model is far less capital-intensive than actual asset ownership, relieving a company like Smart Share Global of the need to own all of the cabinets and chargers in its network. Instead, the burden of asset ownership and maintenance falls to the company’s business partners, leaving Smart Share Global to earn money by charging those partners for hardware sales and service fees.

The company intends to keep the direct-ownership model as part of its business going forward, though Xin admitted that part of its mix is “still a bit under the water in terms of profitability.”

At the end of March, nearly 80% of the charging cabinets in Smart Share Global’s network were operated by its business partners, with the remaining 20% self-operated. That marked a big shift from a year earlier when just 58.8% of its cabinets, called “points of interests” in its reports, were operated by third parties. Its partners totaled 11,000 at the end of March, up by 3,800 year-on-year.

As those third parties took over more direct operations, they collected a growing slice of the revenue consumers pay for charging their phones. As a result, Smart Share Global’s revenue from mobile charging fees dropped 53.5% to 378 million yuan in the first quarter from 813 million yuan a year earlier. Its revenue from sales of chargers and charging cabinets to its partners jumped to 164 million yuan from just 11.7 million yuan a year earlier. It also generated 59 million yuan for charging solutions like the payment settlement services we previously mentioned, up from nil the previous year.

We expect that those newer categories, namely cabinet sales and charging solutions, will continue to grow at a strong clip as the company’s new business model matures. The lone analyst who covers the company expects the company’s revenue this year to fall 25%, suggesting the declines should start to moderate in the second half of the year.

Aside from lower capital costs, the new business model also appears to be benefiting Smart Share Global in the form of sharply lower marketing costs. Such costs fell by around two-thirds to 205 million yuan in the latest quarter from 665 million yuan a year earlier.

As we’ve previously mentioned, the company sank into the red with a 300,000 yuan loss for the quarter, reversing a 10.8 million yuan profit a year earlier. It was still profitable on an adjusted basis, though its 3.8 million yuan profit in those terms was down sharply from a 17.1 million yuan profit a year earlier.

At the end of the day, this Energy Monster is in the process of taking some painful medicine that’s undermining its performance in the short-term to ensure its longer-term profitability. We would generally commend it for taking the step, which should ultimately result in a meaner and leaner Monster that could even potentially grow by gobbling up one of its competitors.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.