SINA and Weibo: Falling Knives or Undervalued Stocks?

SINA (SINA) spun off Weibo (WB 3.73%) in an IPO five years ago, but it still retains a majority voting stake and generates most of its revenue from Weibo. The two companies remain joined at the hip, so a slowdown at Weibo can wreck SINA's earnings.

That's what happened when both companies posted their first-quarter earnings on May 23. Weibo's revenue rose 14% annually to $399.2 million, but marked its slowest growth rate since its IPO. That slowdown caused SINA's revenue to rise just 8% to $472.5 million, which represented its slowest growth in three years.

Image source: Getty Images.

Those soft numbers, along with the ongoing sell-off in Chinese tech stocks, caused SINA and Weibo to tumble to multiyear lows. However, the sell-off reduced SINA's and Weibo's forward P/E ratios to just 10 and 12, respectively, which marked historical lows for both stocks. Do those low multiples indicate that SINA and Weibo are undervalued, or are they both falling knives?

How bad is the slowdown?

SINA's and Weibo's revenue growth was throttled by two factors -- slower spending on ads, due to China's economic slowdown, and the depreciation of the RMB, since both companies report their earnings in U.S. dollars.

YOY = Year-over-year. Source: Quarterly reports.

That slowdown wasn't surprising, since Baidu (BIDU 1.24%) and Tencent (TCEHY 1.91%) also recently reported slower advertising growth. Baidu's ad revenue  rose just 3% annually last quarter, while Tencent's ad revenue grew 25% -- compared with 55% growth a year earlier.

SINA and Weibo don't expect the situation to improve anytime soon. Weibo expects its revenue to rise just 0% to 2% annually (7% to 20% on a constant currency basis) in the second quarter.

SINA didn't provide any guidance, but Weibo accounted for 84% of its revenue during the first quarter -- so Weibo's weak guidance indicates that SINA could post flat to negative sales growth in the second quarter.

Depending too much on online ads

Weibo and SINA are being punished because they rely too much on online ads. Weibo generated 85% of its revenue from ads during the first quarter. The remaining 15% came from value-added services like virtual gifts on its live video streaming platform.

Weibo's ad revenue rose 13% annually during the quarter as its VAS revenue rose 24%. The growth of its VAS business is encouraging, but it's far too small to offset the slowdown of its core advertising business. On the bright side, Weibo's monthly active users grew 13% annually to 465 million.

SINA generated most of its revenue from Weibo. The rest came from its aging portal business, which includes its news portals and fledgling fintech business. Revenue from that smaller unit fell 10% to $81.8 million, as a 30% jump in nonadvertising revenue (43% of the unit's sales) failed to offset a 27% drop in its advertising revenue.

The weakness of SINA's portal advertising business indicates that advertisers are sticking with bigger platforms -- like Baidu, Tencent's WeChat, and Weibo -- as the economic slowdown forces them to rein in their marketing expenses.

Image source: Getty Images.

What about the margins?

SINA's and Weibo's sales are hitting a brick wall, but their margins aren't crumbling yet.

Source: SINA Q1 report.

SINA attributed the improving gross margin of its portal site to higher-margin ads, which were only slightly offset by lower margins for its nonadvertising businesses. Weibo's margin dipped due to the growth of its lower-margin VAS business.

SINA's operating margin expanded from 22% to 24%, while Weibo's stayed roughly flat at 34%. This indicates that both companies are maintaining tight control over their spending as their growth decelerates.

SINA's non-GAAP net income fell 18% to $28.9 million, but its EPS of $0.40 still beat expectations by $0.03. Its GAAP net income, which was boosted by the sale of an investment, rose 15% to $33.1 million.

Weibo's non-GAAP net income rose 14% to $128.5 million, or $0.56 per share, which beat expectations by $0.04. Its GAAP net income rose 52% to $150.4 million.

Neither company provided any bottom-line guidance, but analysts expect Weibo's and SINA's non-GAAP earnings to rise 11% and 10% this year -- which are decent growth rates relative to their forward P/E ratios.

The bottom line

SINA's and Weibo's first-quarter numbers were disappointing, but both stocks look cheap and should recover if a trade deal is reached and the RMB rises again. I wouldn't hold my breath for a quick recovery, but I don't think either tech giant is headed off a cliff yet.