Weibo's (WB 4.50%) business has delivered plenty of impressive growth statistics that help make the case for owning the stock. Last quarter saw the company's daily active users increase 26% year over year, while monthly active users were up 28%. These user additions, along with improved engagement and increased advertiser spending, helped push year-over-year sales and net income up 71% and 144%, respectively -- and Weibo shares have now gained nearly 140% year to date.
That's a performance worth celebrating, but with the company priced for stellar growth at roughly 60 times forward earnings estimates, it's also important to consider conditions that could disrupt the company's growth story. Read on for a look at a key risk factor that Weibo would prefer shareholders not to focus on.
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Government regulation presents a real threat
China's government and economic system provides considerable advantages for large, domestic companies operating in the country, but the potential for state interference also creates substantial uncertainty and risk. Weibo came up against that reality and a potentially significant road block to its growth story on June 22, when China issued a shutdown notice for the company's video and audio live-streaming services. Most of Weibo's other video and audio content is hosted by a third-party provider, so it's still not clear what effects this will have on Weibo's business over the long term, but it's an issue that shareholders should keep a close eye on.
In the company's August 2 earnings call, CFO Cheng-Chun Yu stated that the impact of the notice on the company's overall video operations has been limited and went on to give a little more insight into the situation. Check out this Yu quote from a transcript courtesy of S&P Global Market Intelligence: "Since Weibo is not a wholly state-owned or a state-controlled company and we were not operating prior to January 31, 2008, we are not qualified to obtain the internet, audio, video program transmission license under the current legal regime although we plan to apply for such license when feasible to do so."
Yu then directed those interested in the issue to the risk-factors section of Weibo's most recent Form 20-F filing, which was published on April 27, and said the company would not be able to offer further comment on the topic during the call. Here's a relevant segment from the document:
The PRC [People's Republic of China] government extensively regulates the internet industry, including the licensing and permit requirements pertaining to companies in this industry. Internet-related laws and regulations in China are relatively new and evolving, and their interpretation and enforcement involve significant uncertainty. As a result, it may be difficult to determine what actions or omissions may be deemed to be violations of applicable laws and regulations in certain circumstances.
The filing also states that Weibo cannot guarantee it has all the necessary permits for operating in China, that it will be able to maintain its current licenses, or that it will be able to secure new licenses that become necessary for continued operation. Other risks related to government regulation include changes to, or unexpected enforcement of, lending and investment guidelines and the possibility that virtual currencies used in the company's video game services will face tighter restrictions.
The government even regulates consumption
Weibo generates relatively little revenue from video games. However, recent developments in the space highlight another potentially worrying dynamic for the company with regard to government involvement. After increasing pressure from state media, Tencent Holdings introduced a policy for its games that limits play time to one hour per day for users under the age of 12, and two hours per day for users between the ages of 12 and 18. There are no official rules in place to curb citizens' internet usage or spending on online services, but the possibility exists that some manner of legislation could be forthcoming, and it's clear that companies can be pressured to make changes even without official government action.
The bottom line
China has shown that it's not only interested in regulating content, but also influencing the extent of consumption. The potential merits and drawbacks of government involvement in these spheres are up for debate, but the possibility of state action that has a unfavorable, material impact on Weibo's business and growth prospects is something that investors should keep in mind.
