Where Have China's Dot-Com Darlings Gone?

Buying into China's tech elite hasn't paid off lately.

Most of the country's most popular Internet companies -- many coming off of long histories of trading excellence or recent IPOs that popped out of the gate -- aren't hitting new highs the way some stateside tech darlings are.

What went wrong? Which names will bounce back? When will they bounce back?

These are some meaty questions. Let's tackle them all.

What went wrong?
Since most retail and even institutional investors don't have a great feel for China's Internet scene from the consumer perspective, it's often easiest to just compare them to their stateside proxies.

• Baidu (BIDU 5.01%) is the Google (GOOG 3.44%) of China.
• Dangdang (DANG +0.00%) is the Amazon.com (AMZN 1.97%) of China.
• Youku.com (NYSE: YOKU) is China's YouTube.
• SINA's (SINA +0.00%) Weibo is the Twitter of China.
• Renren (RENN +3266.67%) is China's Facebook (FB 8.00%).

The comparisons don't always hold up.

Baidu in the role of Google is fair. In fact, Baidu commands 75% to 80% of the search queries performed in the world's most populous nation. That's better than Google serving up roughly two-thirds of the searches closer to home. One can always argue that Baidu is a distant laggard in the countries outside of China where it has started to branch out. Big G is the market leader in many global markets. However, it's still a reasonably fair comparison.

Dangdang, on the other hand, was a lousy body double for Amazon. When Dangdang went public two years ago, most of its items were books. Yes, this was Amazon circa 1995 -- when it was billing itself as "the world's largest bookstore" -- but Amazon evolved quickly. Dangdang continues to make inroads in general merchandise, but there are plenty of larger players in China doing that.

Youku was China's leading video-sharing website when it went public two years ago, but it doesn't have anywhere near the market dominance that YouTube commands among free sites. Chinese traffic tracker Analysys pegs Youku as commanding 20.9% of the video streaming market, and the recently acquired Tudou as contributing an 11.5% slice. In other words, it's still roughly a third of the market.

SINA has been trading publicly for years, but the rapid success of its Twitter-like micro-blogging platform Weibo has given the online portal new life as a trendy tastemaker. It may be warranted, but -- like Twitter -- SINA's only just starting to crack open the monetization potential of its fast-growing website.

Renren traded as high as $24 the day that it went public last year. Just as the market saw with the 2010 debuts of Dangdang and Youku, the tags aren't always appropriate. There are plenty of companies vying to be the Facebook of China, and the country's restrictive nature that finds Renren verifying user identities may keep the social networking revolution in check in China.

Which names will bounce back?
It's been pretty ugly for some of these companies. Let's see how far the stocks have fallen.

Source: Yahoo! Finance.

Let's take a look at Baidu and SINA first.

It's not a surprise that the only two profitable names on the list are the ones that have held up the best. Baidu has also held up far better than SINA because it continues to grow its bottom line at a heady clip. SINA's margins have taken a hit over the past year as it fortifies Weibo.

It's easy to see both companies bouncing back. Baidu is now trading at just 18 times forward earnings. There are concerns that a smaller upstart is starting to nibble its market share, but we'll get a clearer picture after its earnings report in a few weeks. SINA simply needs to see how the monetization process plays out with Weibo, and if things don't pan out, it can always retreat to its earlier high-margin online endeavors.

The more recent debutantes have it harder. Renren, Youku, and Dangdang are all expected to post steep deficits this year, and only Youku -- fortified by the synergies of its Tudou acquisition -- is expected to turn the corner of profitability next year.

Youku is also in better shape than Renren and Dangdang. Streaming is growing in popularity in China, and Youku's positioning has helped it strike deals with major Chinese and American movie studios. The valuation is still quite steep, but it should pay off here in the teens for patient long-term investors.

Renren and Dangdang may never get out of the single digits. Both companies have posted wider-than-expected deficits in three of the past four quarters. Speculators wooed by the low prices will create volatility and perhaps even the occasional pop, but Renren and Dangdang eventually need their fundamentals to improve if they want to be taken seriously.

When will they bounce back?
They won't all bounce back at the same time. Even after investors are comfortable again buying back into China's dot-com leaders, every company is different.

Baidu is good to go right now. It's trading at a huge discount to its growth rate. Careful investors may want to wait until its next quarterly report to assess the summertime threat of a potential disruptor in China, but Baidu's at a price that's too tempting to ignore.

SINA may have to wait a bit longer, but only until the SINA Weibo advertising initiatives begin to bear fruit. Youku may bounce back into favor sooner than SINA if it's first wave of post-Tudou quarterly reports show substantial improvement.

When Youku went public in late 2010 it had posted negative gross margins through the first nine months of the year. Yes, cost of revenue outweighed revenue. The Tudou deal will change everything.

As for Renren and Dangdang, they are years away from bouncing back -- if they bounce back at all.

So tread carefully in the Chinese dot-com minefield. There are deals to be had, but you don't want to get blown away by buying the wrong company at the wrong time.

Betting on China
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