Will You Buy the Facebook of China?

With the market on the rebound, the hot IPOs keep coming. Since I took the space last week to tell you about one that is definitely worth your interest, I thought I would use it this week to warn you about one that is definitely not. The company that's in that latter category is Renren, the soon-to-be-public-on-the-NYSE Internet company that the media likes to call the "Facebook of China."

While Renren and Facebook do share a number of similarities -- both are real-name social networking sites, for example -- what they have most in common is eye-popping valuations. For Facebook, that's an outlandish $78 billion as of March. For Renren, it's almost $4.4 billion -- a somewhat smaller, but still outlandish amount.

There are, however, some potential reasons to get excited about the chance to own a piece of Renren. With some 400 million Internet users, China is already the world's largest Internet market -- and that's despite the fact that only 30% of the population is online. Furthermore, fewer Chinese Internet users engage in social networking than their global peers, making this a space ripe for hyper-growth. Finally, while Renren is not quite engaging users as well as Facebook, it's close -- with the average user spending 15 minutes on the site.

But before you get too excited about the market opportunity and set your alarm for the May 4 IPO date, there are a few things you should know about Renren …

Buyer beware
First, if you buy shares of the Cayman Islands-based holding company, you don't actually own the operating company in China. That company, Beijing Qianxiang Tiancheng Technology Development, will remain 99% owned by Renren CEO Joe Chen's wife, Jing Yang (a Chinese citizen). There will be a contract in place that entitles you, a foreign shareholder, to the economic benefits of the company. That may sound like a neat way to circumvent Chinese restrictions on foreign ownership of telecommunication assets, but good luck getting that contract enforced in Chinese court should Ms. Yang choose not to honor it. Further, a dual-class share structure that limits the influence of outside shareholders means that Joe Chen and his wife hold all of the cards here.

Second, unlike Facebook here in the U.S., Renren is not the clear leader in the social networking space in China. There are a number of competitors, including two backed by cash-rich Chinese Internet giant Tencent.

Third, while Joe Chen is often called the "founder" of Renren, he's not actually the heart and soul of the technology like Bill Gates was at Microsoft or Mark Zuckerberg at Facebook. These zealots spearheaded years of innovation at their respective companies and earned early investors incredible returns in the process. Rather, Chen acquired the platform from some Chinese college students in 2006. As Kai Lukoff reported at Mashable, it's actually competitor kaixin101.com that has the innovative founder.

Finally, know that the reason Facebook isn't the Facebook of China is because the site is blocked there by Chinese government censors. Recently, however, it's been rumored that Facebook is looking to team up with Chinese search giant Baidu (Nasdaq: BIDU  ) to launch a new social networking service in China. Having such an influential local partner might help Facebook make inroads in China and would undoubtedly be a massive threat to Renren's long-term position.

In light of these facts
It bears repeating that the proposed valuation here is truly ridiculous. According to its registration statement, Renren earned $11.1 million in EBITDA from advertising and gaming revenue of $76.5 million. Buying shares at the IPO, then, would have you paying 57 times sales and 396 times EBITDA. See how that compares with other high-growth and solidly profitable emerging market tech businesses:

Company

EV/Sales

EV/EBITDA

Baidu

42.8 times

77.1 times

Tencent

16.7 times

31.4 times

MercadoLibre (Nasdaq: MELI  )

18.0 times

49.1 times

Mail.ru Group

32.9 times

195.0 times

Sina (Nasdaq: SINA  )

18.5 times

58.0 times

Sources: Capital IQ (a division of Standard and Poor's) and author's calculations.

About the only company Renren looks cheap next to is another recent China Internet IPO -- Youku.com (Nasdaq: YOKU  ) . That's because Youku, the "YouTube of China" is even more of a story stock and even worse at making money.

The global view
The bottom line is that if you're going to pay up for Renren, you need to believe in at least three realities. First, that Renren will be the dominant social networking site in China in 10 to 20 years. Second, that Renren will have figured out more and better ways to monetize its traffic. Third, that foreign shareholders of Renren will end up benefiting from its success.

While all three of those are open questions in my mind, the most challenging for me is believing Renren will end up king of China's social networking hill. It's not there now, it's not run by the most innovative team, and more and more competition is coming.  That's why investors should pass on this IPO.

Get Tim Hanson's top global stock picks by joining Motley Fool Global Gains. Tim's "Global View" column appears every Thursday on Fool.com.

Tim Hanson is co-advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. The Fool owns shares of Microsoft. MercadoLibre is a Rule Breakers recommendation. Microsoft is an Inside Value selection. Sina is a Stock Advisor choice. 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.


Read/Post Comments (5) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 28, 2011, at 11:55 AM, bottomfisherman wrote:

    Social Networking "Its going to bring you (your portfolio) down, huh." With my apologies to Slash, Axl et al.

  • Report this Comment On April 28, 2011, at 5:44 PM, xetn wrote:

    The Chinese government has a history of using the "internet kill switch" any time it sees negative comments being made against it or its policies.

    So, do you want to own a company whose content could lead to its own destruction?

    This is what happened to YouTube, Facebook and others in 2009 during the Tibet crisis and I believe they are still blocked in China (as far as I know).

  • Report this Comment On April 29, 2011, at 4:15 PM, Solumex wrote:

    Hi there Tim, nice article !!

    About RenRen it could be very interesting to compare VS QPSA

    Sales vs Users

    Loss vs Sales

    I made a small research ( im not an expert and could miss a lot of things ) and the QPSA is way better that RenRen

    I know QPSA is not a popoular stock buy I do firm belive it will be a top player in Social Media Market.

    You comment that one of the RenRen competiors is a Internet Giant and bringing it to QPSA, the strongest rumor on QPSA is not Facebook could takeover, the right direction, as my opinion, point to Carlos Slim, and he is a Internet GIANT in Latino America and please do not forgot he owns also AmericaMovil, LatinAmerica leader for mobil telephony.

    Telcel company ( America Movil Mexican Brand ) is promoting a campain named SOCIAL MEDIA to offer access to all Social Media Sites via Telcel Smart Phones.

    Once again, thanks for your article.

    Solu

  • Report this Comment On May 01, 2011, at 1:54 PM, cattywampus wrote:

    Tim, thanks for the continuing public education on the risks of Chinese investing. Cayman Island holding companies, reverse mergers, restrictions of foreign ownership and intricate contractual provisions all leave me scracthing my head. Doing your due diligence on some of these companies seems almost impossible without help, yet the temptation of such a big potential market is an opportunity that is hard to resist.

  • Report this Comment On May 03, 2011, at 3:48 PM, TMFMmbop wrote:

    Glad Fools enjoyed the article. It will be interesting to see how this one trades out of the gates!

    Tim Hanson

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