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Can Sina's Business of Censored Free Speech Survive?

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

The very existence of Sina Corp. (NASDAQ: SINA), the Chinese Internet portal site that created microblogging site Weibo, is a paradox.

Weibo, which is widely regarded as “China’s Twitter,” depends on the rapid exchange of freely expressed ideas. Yet the company is based in authoritarian China, in one of its most highly oppressed growth industries -- Internet technology. For every two steps Sina takes forward, it must take one back and censor its own channels in order to play nice with the Chinese authorities. Is this business model of “regulated and censored” free speech sustainable? Is Sina’s growth potential worth the risks of an abrupt shutdown?

Chinese Macro 101: Enough is Never Enough

First and foremost, Sina’s future growth is dependent on major macro factors in China. In the fourth quarter of 2012, China’s GDP rose 7.9% over the prior year quarter, and 2% sequentially, exceeding expectations. This alleviated some concerns that China was headed for the “hard landing” that brought down Brazil after years of feverish growth.

A strong and stable GDP is important to fuel Sina’s primary source of revenue -- online display advertising. In 2012, China’s online advertising market grew 47.6%, an impressive figure that nevertheless failed to measure up to the 57.6% growth it reported in 2011.

This perceived slowdown has also dragged down its Chinese Internet peers Baidu (NASDAQ: BIDU) and Sohu.com (NASDAQ: SOHU). Investors should remember that when investing in China, double (or triple) digit growth is not impressive -- unless it exceeds the prior year’s growth.

A Frustrating Fourth Quarter

For its fourth quarter, Sina’s earnings plunged 74% to 14 cents per share, or $2.4 million. Meanwhile, revenue grew 4.3% to $139.1 million. However, those uninspiring results were still enough to top the Thomson Reuters consensus, which called for earnings of 5 cents per share on revenue of $133.9 million.

Wall Street had been expecting the worst from Sina and its Chinese Internet peers due to weakening online advertising numbers and shaky GDP growth.

Yet Sina’s advertising revenue rose 6.8% to $110.7 million, primarily boosted by strong results at Weibo. Non-advertising revenue, which includes other investments, slid 4.2% to $28.5 million as a result of failed equity investments and a related impairment charge.

Monetizing Weibo

Weibo has been the most popular microblogging site in China for several years now, but Sina had struggled in the past with monetizing its growth -- a similar dilemma facing its western counterparts Facebook and Twitter these days.

Sina recently added a feature that allows advertisers to "tweet" to users not directly following them, a somewhat intrusive tactic similar to Facebook’s News Feed ads. It also started linking its most followed microbloggers to advertisers.

During the fourth quarter, Weibo’s daily active users grew by 82% over the prior year quarter to 46.2 million users -- and 75% of these users accessed the site through mobile devices. Smartphone advertisements generated 30% of Weibo’s total revenue. Sina CEO Charles Chao expects this number to increase through 2013, as the adoption rate of smartphones and tablets continues to rise.

Tencent Takes Aim

Chao admitted that smartphone users were spending less time on Weibo, and more time using WeChat, a text and voice messaging application created by its rival Tencent Holdings. WeChat is available on all major smartphone platforms, and has a user base of more than 200 million. In addition to WeChat, Tencent also owns Tencent QQ, China’s most popular instant messaging desktop application, with over 670 million users.

However, Chao downplayed Tencent’s recent gains, stating, “Weibo has reached a critical mass and will continue to grow in user base and user activity given its network effect.” By “network effect,” Chao believes that Weibo will become a self-growing system similar to Facebook and Twitter, which branches and spreads outward -- as opposed to Tencent’s messaging applications, which are generally confined to pre-existing contacts. In other words, users can’t attract followers or fans with Tencent’s software.

Building your own Ministry of Truth

You’d think that all this free speech and people attracting followers would make the Chinese government nervous. Let’s say an irate Weibo user with a large following tweets to his followers, “Let’s all meet up for the anniversary of the #Tiananmen Square massacre to demand a #Free Tibet and #Taiwanese independence!”

To deter that from happening, the Chinese government now requires all Internet users to provide their real names, and has thoroughly cracked down on message boards and social media sites such as Weibo that contain “illegal” information.

To avoid this fate and to remain in good standing with authorities, Sina is required to police itself by hiring censors who erase "offensive" messages as soon as they are posted. Sina has to hire so many censors to build its own "Ministry of Truth" that analysts have been increasingly worried about rising labor costs. Sina acknowledged that labor expenses, combined with networking infrastructure and sales department costs, will likely rise throughout 2013 as a result.

The Foolish Fundamentals

Sina faces the same challenges as all of its industry peers. Therefore, we should compare Sina’s fundamentals to its rivals and see how its valuation and growth metrics stack up.

<table> <tbody> <tr> <td> </td> <td><strong>Forward P/E</strong></td> <td><strong>5-year PEG</strong></td> <td><strong>Price to Sales (ttm)</strong></td> <td><strong>Debt to Equity</strong></td> <td><strong>Return on Equity (ttm)</strong></td> <td><strong>Profit Margin</strong></td> </tr> <tr> <td><strong>Sohu</strong></td> <td>13.65</td> <td>1.43</td> <td>1.68</td> <td>17.38</td> <td>13.36%</td> <td>8.17%</td> </tr> <tr> <td><strong>Baidu</strong></td> <td>13.34</td> <td>0.54</td> <td>8.69</td> <td>43.88</td> <td>47.73%</td> <td>46.88%</td> </tr> <tr> <td><strong>Sina</strong></td> <td>34.61</td> <td>3.38</td> <td>7.09</td> <td>No debt</td> <td>2.89%</td> <td>6.00%</td> </tr> <tr> <td><em>Advantage</em></td> <td>Baidu</td> <td>Baidu</td> <td>Sohu</td> <td>Sina</td> <td>Baidu</td> <td>Baidu</td> </tr> </tbody> </table>

Source: Yahoo Finance

Baidu, the “Google of China,” is the hands-down winner. With control of approximately 80% of the Chinese Internet search market, top margins in its industry, and fundamentally cheap valuations, it’s no wonder that Baidu is one of the most popular Chinese stocks with foreign investors. The one fundamental strength Sina has, however, is an important one -- a clean balance sheet with no outstanding debt.

Let’s also check the three companies’ top and bottom line growth over the past five years.

<img src="http://media.ycharts.com/charts/42fb27c1c415b7736b99d35cf6325ff0.png" />

SINA Revenue TTM data by YCharts

Baidu still comes out on top, but Sina is quite disappointing. Sina also faces a classic Internet growth problem -- revenue growth outpacing earnings growth.

The Foolish Bottom Line

Sina is not an investment for the faint-hearted. The stock has a beta of 1.4, which means investors can expect some major turbulence, exacerbated by major headwinds of Chinese economic growth and Internet regulation. Although the company has a clean balance sheet, its margins are low compared to its industry peers. Sina’s forward valuations also suggest that the stock is overpriced with sluggish growth ahead.

For now, investors interested in China should stick with the stock they know best -- Baidu -- until Sina can stabilize its top and bottom line growth.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Baidu, SINA , and Sohu.com. 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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