Is This the Best Chinese Internet Play?

Dan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Renren (NYSE: RENN) is an enigma to many investors. The stock has a reputation for extreme volatility, which is justifiable considering a beta of 3.58.

Traders love volatility, but investors prefer not to deal with it. Savvy investors desire steady gains and dividend payments. You won’t find either of those here. Actually, despite some short-term pops, the stock has only headed in one direction since its IPO -- down.

Those bullish on Renren point to top-line growth, but that might not be enough considering strong headwinds.

The current situation

Revenue grew over the past two years, but two of the last three years have seen losses, and the past five quarters have been in the red. In addition to top-line growth, those bullish on Renren also like to point out a stellar balance sheet with $850 million in cash and no long-term debt. This strong cash position gives Renren an opportunity to please investors. For instance, the board recently approved a $100 million buyback program, which will replace a $150 million buyback program that began in 2011.

While share buybacks are a positive for investors, they don’t indicate what’s going on with the underlying business. Since Renren is an online business, the first place to start is traffic trends for its websites. If traffic is growing, then revenue through advertising is likely growing, and vice versa.

Think of Renren.com as the Facebook of China. It’s a social networking site that also operates through online gambling and online advertising. The site ranks No. 132 globally for traffic, and that ranking has increased eight spots over the past three months. Renren.com currently has approximately 184 million users, which is a high number, but it’s nothing compared to China’s overall population of 1.4 billion. Therefore, growth potential is high.

Think of Nuomi as the Chinese version of Groupon. Traffic for Nuomi.com has been steady over the past two years. The most impressive number here is that 54% of customers are recurring. Nuomi.com currently sports a global traffic ranking of No. 1,542, up an impressive 242 spots over the past three months.

Renren wanted to cover as many bases as possible, including the Chinese version of YouTube. This site goes by the name of 56.com, and it sports a global traffic rank of No. 125, up 23 spots over the past three months.

Looking ahead

Renren wants to diversify its content, but this type of expansion comes with costs. With user growth up 19% and gambling revenue jumping 51% last quarter year over year, Renren is confident in its future prospects. This is in addition to a strong push in mobile -- in the first quarter, mobile accounted for 74% of user time. This is an excellent sign because it shows that Renren is moving with industry trends, and because it has captured the interest of the younger generation, which will allow the company to grow with that population.

The headwinds might seem simple, but they shouldn’t be underestimated. These headwinds include a slowdown in advertising, slowing growth in the Chinese economy, and fierce competition. Advertisers aren’t as confident in the direction of the economy as they had been in the past, which makes sense considering all the borrowed money for ghost cities and an infrastructure that most people don’t use. The Chinese economy is beyond a bubble; it’s a hot air balloon. Unfortunately, Renren won’t be capable of thriving once reality sets in and drags the Chinese economy down. 

The competition

Baidu (NASDAQ: BIDU) owns a global traffic rank of No. 5, unchanged over the past three months. It’s also the most visited website in China. Online traffic isn’t showing any signs of slowing. Over the past three months, page views-per-user increased 8.71%, and time-on-site grew 9%. Revenue and earnings have consistently improved on an annual basis, and the balance sheet is strong, with $5.39 billion in cash and $1.90 billion in long-term debt. You can think of Baidu as the Chinese version of Google. However, the company’s fundamentals are so strong that many questions have arisen about accounting practices. To this point, any wrongdoing is nothing more than speculation, but these fears should be noted. 

Sina.com (NASDAQ: SINA) owns a global traffic rank of No. 3,612, up 132 spots over the past three months. You can think of Sina as the Chinese version of Yahoo. But Sina’s real power engine is Weibo.com -- the Chinese version of Twitter. Weibo.com has a global rank of No. 27, up two spots over the past three months. Keep in mind that the higher the ranking, the slower the move. Weibo.com has a ton of potential, but over the past three months, pageviews-per-user has declined 7.86%, and time-on-site has dropped 7%.

Sina’s revenue has consistently increased annually, but earnings have been inconsistent. Sina delivered a gain in 2012 after two years of losses, which is a positive sign. Sina’s balance sheet also qualifies as excellent, with $687 million in cash and no-long term debt.

Conclusion

Renren has shown that it’s capable of growth, and its potential would be good under normal circumstances, but downside risks for the Chinese economy are strong. If confidence wanes, advertisers and consumers will slow, thereby negatively impacting Renren’s business. The company’s inability to turn a consistent profit is also concerning. Overall, Renren is a high risk/high reward investment, but at this point in time, downside risks look to outweigh potential rewards. 


Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Baidu and SINA . The Motley Fool owns shares of Baidu. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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