Weibo (WB -2.77%), a Chinese social media company that is frequently compared to Twitter (TWTR), might seem like an undervalued growth stock. Its microblogging platform served 573 million monthly active users (MAUs) last quarter, up 12% from a year ago, while its revenue rose 39% year-over-year in the first nine months of 2021.
Analysts expect Weibo's revenue and earnings to rise 33% and 29%, respectively, for the full year. It faces easy comparisons to its slower growth throughout the pandemic last year, but its stock looks cheap at just nine times forward earnings and about three times next year's sales. Unfortunately, four red flags indicate the stock could be a value trap.
1. Sina's privatization
Sina, one of China's oldest internet companies, spun off Weibo in an IPO in 2014. However, Sina still maintained a majority voting stake in Weibo and relied on the social network to generate a large portion of its revenue.
In early 2021, Sina took itself private and delisted its shares from the NASDAQ. The $2.6 billion deal -- which handed Sina over to New Wave, a holding company owned by Sina's CEO -- arguably undervalued Weibo, and didn't seem to assign any value to Sina's other businesses at all.
At the time of its privatization, Sina still owned a 44.9% equity stake in Weibo, which gave it 71% voting control in the company. Weibo had a market cap of nearly $12 billion on the day Sina delisted its shares, so a 44.9% stake in the company was worth a lot more than $2.6 billion.
Sina's investors couldn't block the lowball deal because New Wave also held a majority voting stake in Sina. That delisting burned a lot of U.S. investors, who had considered Sina an arbitrage play on Weibo. It also sparked rumors that Weibo might also take itself private at a steep discount, and revealed just how little control Weibo's foreign investors actually wielded against Sina.
2. Weibo's disappointing Hong Kong IPO
Weibo denied those privatization rumors in July, and its IPO in Hong Kong in December indicated it still wanted to remain publicly traded.
Unfortunately, Weibo's IPO in Hong Kong didn't impress many investors. It priced its shares at 272.80 Hong Kong dollars ($34.98), but the stock closed at 253.20 HKD ($32.47) on the first trading day and is now only worth about 225 HKD ($28.85). That busted IPO indicates Chinese investors aren't too optimistic about Weibo's future either.
3. Alibaba's big divestment
Alibaba (BABA -0.74%) bought an 18% stake in Weibo right after its IPO in 2014. That stake had risen to 29.6% as of Sept. 2021, making Alibaba the company's second-largest stakeholder after Sina.
For years, Alibaba's stake in Weibo sparked speculation that the e-commerce and cloud giant could acquire the social media company. However, recent reports suggest that Alibaba could sell that stake to the state-backed media company Shanghai Media Group.
Alibaba might consider making that divestment to appease antitrust regulators and reduce the government's scrutiny of its media-related investments. Tencent also recently made a comparable concession by divesting its stake in the e-commerce giant JD.com.
Alibaba's potential divestment raises red flags for Weibo, for two reasons: A sale to a state-backed media company could introduce even tighter censorship restrictions for the social network, and it could limit Weibo's future integration into Alibaba's platforms.
In the past, Weibo directed its users toward Alibaba's online marketplaces, and it used AliPay (from Alibaba's affiliate Ant Group) to power its Weibo Payments platform. The removal of those features could hurt both companies.
4. The regulatory headwinds
Lastly, Weibo isn't immune to China's crackdown on its top tech companies. Its public relations director was arrested in August on bribery charges, and the Cyberspace Administration of China (CAC) recently fined Weibo three million yuan ($471,031) over vague allegations of inappropriate content.
That's a slap on the wrist for a company that is expected to generate $2.25 billion in revenue this year, but it indicates the government will continue to closely police and censor Weibo's content. That scrutiny could intensify significantly if Alibaba sells its stake to Shanghai Media Group.
In the past, Weibo spent a lot of money developing AI algorithms and hiring teams of censors to monitor its content in real time. If the Chinese government wants Weibo to exert even stricter censorship standards, its operating expenses could surge and throttle its earnings growth.
Even if Weibo overcomes its regulatory challenges in China, it still needs to address the looming delisting threats in the U.S., where securities regulators have been tightening their auditing requirements for foreign companies.
Weibo's stock is cheap for obvious reasons
Weibo might initially seem like a compelling alternative to Twitter and other American social media companies. However, Weibo's stock is cheap because it faces far too many near-term challenges. Investors should wait for these headwinds to dissipate before rerating Weibo as a value play.