RENREN INC RENN
April 29, 2017 - 12:14am EST by
pistolpete
2017 2018
Price: 7.38 EPS 0 0
Shares Out. (in M): 68 P/E 0 0
Market Cap (in $M): 504 P/FCF 0 0
Net Debt (in $M): 24 EBIT 0 0
TEV ($): 527 TEV/EBIT 0 0

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Description

 

 

Note: Renren recently underwent a 1-for-5 reverse split in its US-listed ADS on 2/6/17. Each ADS now represents 15 ordinary shares. For the purpose of this investment write-up, all calculations will be in ADS.

We are recommending a long position in Renren Inc. (NYSE: RENN, “Renren”, “the Company”) for the following reasons:

(1)     Abysmal deterioration of core-Renren business clouds the significant value of the long term investments Renren has made over the years, providing optionality and margin of safety

(2)     Unique situation of a public entity spinning out a private equity vehicle causes both institutional and retail shareholders to be unable to hold shares in aforementioned private equity vehicle, which has caused the shares to sell off, offering attractive entry price

(3)     Large insider ownership by a management team that is also incentivized to strip assets (more on why this a good thing later)

(4)     Near-term catalyst where investment is expected to return between 14.4% and 21.4% within the next two quarters

 

Background:

Renren (NYSE: RENN) operates a real-name social networking service (SNS) and an internet finance business in China. The Company IPO’d in May of 2011 to much fanfare. At the time Renren was hyped as the Facebook (real-name SNS), Zynga (mobile / social gaming), YouTube (user-generated video content), and Groupon (group-buying business) of China. In May of 2011, Renren was able to raise $740mm in an IPO where 53.1mm shares priced at $14 then rose to $20+ in the first day of trading. At the time the business had a market cap north of $7bn. Fast forward to 2017, RENN has since sold off its Zynga, YouTube, and Groupon-like businesses. And after a several quarters of earnings misses, inability to grow RENN’s SNS business beyond its initial user base of college students, and accelerating decline in MAU, the core RENN business looks like it’s headed towards a zero. On a pre-reverse split basis, each ADS currently trades at $1.48, some 93% lower than its ~$20 highs and only 0.4% above its all-time low of $1.47.

 

Now, while Joseph Chen has been an excellent destroyer of shareholder value, he has been quite successful moonlighting as a VC investor. A quick look at RENN’s balance sheet shows the multitude of investments that management has made over the years including significant stakes in notable fintech start-ups (SoFi, Fundrise, LendingHome, and Motif Investing) to limited partnership stakes in macro hedge funds (Kyle Bass’ Hayman Capital). As of the quarter ending 9/30/16 (last available data), RENN held $751.4mm of long term investments on its balance sheet.

 

This figure, which we believe to be conservative due to the fact that RENN does equity method accounting for several of its investments, is already greater than RENN’s current total enterprise value of $503.5mm (using last available balance sheet data from 9/30/16). If one nets out these investments, the core-Renren business is attributed a negative total enterprise value of (~$200mm+).

 

Situation update:

We believe RENN management is well aware that their core business is headed towards a zero. The core business is unlikely to ever turn a profit. The number of activated user accounts has plateaued around 230mm. MAU has entered free fall and has been declining YoY at ~20% for the past three quarters. Loss margins are widening. Given that management is aware that they are at the end of the road, we believe management is on a quest to strip RENN of its long term investments from general shareholders in an attempt to enrich themselves.

 

In June of 2015, RENN CEO Joseph Chen and COO James Jian Liu made a preliminary non-binding going-private proposal to the RENN board to buy all outstanding ADS for $4.20 (pre-reverse split price) each (http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2058147).

 

This represented approximately a 22% premium to the average closing share price to the RENN ADS over the previous month. At the time, Chen and Liu beneficially owned 32% of the ordinary shares representing 49% voting power.

 

Cue the uproar. Soon afterwards, institutional shareholders were furious and saw this proposal as a blatant attempt to steal value from shareholders (see: http://www.prnewswire.com/news-releases/open-letter-to-renren-special-committee-board-of-directors-and-all-renren-shareholders-from-private-investors-300149119.html). Angry shareholders argued that the offer price significantly undervalued the RENN on a SOTP basis and management was negotiating in bad faith.

 

Given the outstanding take-private offer, RENN stopped giving guidance in earning releases and stop holding conference calls post earnings. To date, the take-private offer has neither been accepted nor rejected, and RENN has neither given guidance nor held a conference call since the initial offer was made in June 2015.

What is interesting is that in the 20-F filing (10-K equivalent) for FYE 2015, new language emerged in the “Risks Related to Our Business and Industry” section. Specifically, language regarding the Investment Company Act of 1940 was added, whereas it had not been in previous 20-F filings.

 

From the filing:

If we are deemed an “investment company” under the Investment Company Act of 1940, it would adversely affect the price of our ADSs and ordinary shares and could have a material adverse effect on our business.

Our assets include a 21.2% interest in Social Finance Inc., a 20.0% interest in 268V Limited, a 14.7% interest in Lending Home Corporation, a 29.0% interest in Trucker Path Inc. and a 25.3% interest in Rise Companies Corp. These and other investments that we have made may be deemed to be “investment securities” within the meaning of the Investment Company Act of 1940, as amended. As a foreign private issuer, we would not be eligible to register under the Investment Company Act, so if we are deemed to be an investment company within the meaning of the Investment Company Act, we would either have to obtain exemptive relief from the SEC, modify our contractual rights or dispose of investments in order to fall outside the definition of an investment company. Additionally, we may have to forego potential future acquisitions of interests in companies that may be deemed to be investment securities within the meaning of the Investment Company Act. Failure to avoid being deemed an investment company under the Investment Company Act coupled with our inability as a foreign private issuer to register under the Investment Company Act could make us unable to comply with our reporting obligations as a public company in the United States and lead to our being delisted from the New York Stock Exchange, which would have a material adverse effect on the liquidity and value of our ADSs and Class A ordinary shares.

 

On September 30, 2016, RENN announced that it intends to “spin off a newly formed subsidiary ("SpinCo") that will hold the Company's social video platform woxiu.com and most of the Company's investments in minority stakes in privately held companies” (see: http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2207071).

 

From the press release (emphasis added):

The spin-off is being undertaken to minimize the risk that the Company could be deemed to be an "investment company" under the Investment Company Act of 1940 by reducing the aggregate amount of investments in unconsolidated subsidiaries on the Company's balance sheet and to unlock potential in the Company's social video business by separating it from the Company's social networking and internet financing businesses.

 

The Company plans to distribute rights, exercisable for shares in SpinCo, to the Company's shareholders on a pro rata basis. The rights will not be transferable and may only be exercised by shareholders who are both "qualified purchasers" under the Investment Company Act of 1940 and "accredited investors" under the Securities Exchange Act of 1934. The Company will distribute cash in lieu of fractional rights and cash to holders of rights who cannot exercise or who choose not to exercise their rights.

 

The Company plans to distribute no less than 80% of the shares of SpinCo to shareholders that exercise rights and intends for such distribution to qualify, for U.S. tax purposes, as a tax-free distribution to the Company's U.S. shareholders who receive shares of SpinCo in the distribution.

 

Following the spin-off, SpinCo will be a privately held company not subject to public company reporting requirements under the Securities Exchange Act of 1934 and not listed on any stock exchange. The Company intends to remain a public company listed on the New York Stock Exchange.

 

The Company will announce further details at a later date, including the record date for the rights distribution, the ratio of shares of the Company to rights, the distribution date for the rights distribution, the deadline for the exercise of the rights, and the date on which shares of SpinCo and/or cash will be distributed to holders of rights.

 

We view this as an extremely cunning play by management. It’s almost unheard of where a public entity spins off a private equity vehicle, but by coming up with this novel transaction, management has effectively created a win-win situation for themselves. Large institutional shareholders are likely unable to hold a private equity-like vehicle and have undergone forced selling. The majority of retail investors are unlikely to be accredited investors and have similarly undergone forced selling. The market initially reacted positively to the news and RENN ADS rose to $12.35 (post-reverse split price) but after digesting the information, the ADS have continued to sell off to $7.38 today (~40% sell off). This forced selling is driving down the price of RENN shares potentially giving management the opportunity to pick them up at a discount.     

 

On December 5, 2016, RENN announced the appointment of two new independent directors, Stephen Tappin and Tianruo Pu (see: http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2227368).

 

Then, just a few weeks later on December 22, 2016, RENN announced that it had formed a Special Committee to review the terms of the proposed spin-off. The three board members appointed to the Special Committee are Hui Huang, Stephen Tappin, and Tianruo Pu (see: http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2231339).

 

Claim that a legal regulation is forcing you to spin out the valuable assets, and then stack the deck. Cue maniacal laugh.

 

Unfortunately, due to the recent appointment of Tappin and Pu to the board, there has not been a 20-F filing that has detailed their compensation. Hui Huang on the other hand has been a director since January 2015. Although her exact compensation as a board member is not disclosed in 20-F filing, it does indicate that her aggregate beneficial ownership of RENN is less than 1% of total outstanding shares.

 

RENN also disclosed in this press release that the board had received another nonbinding proposal from Chen and Liu (emphasis added):

 

The Company further announced that its board of directors has received a preliminary non-binding proposal to purchase any shares of SpinCo that are not distributed in the proposed spin-off. The letter was from Mr. Joseph Chen, the Company's founder, chairman and chief executive officer, Mr. James Jian Liu, the Company's executive director and chief operating officer, and SoftBank Group Capital Limited, an affiliate of SB Pan Pacific Corporation. Mr. Chen and SB Pan Pacific Corporation are the Company's two largest shareholders. The preliminary non-binding proposal would value SpinCo at US$500 million, net of debt.

 

We view this as an absurdly low offer to purchase remaining undistributed shares of the SpinCo by Chen, Liu, and SoftBank. This offer is lower than the book value of all of RENN’s long term investments, $751.4mm, and our estimation of just RENN’s stake in SoFi’s market value of $753.8mm. And while it can be argued that book values do not always reflect true mark-to-market values, we don’t believe that argument applies here. Management has a clear incentive to understate the values of the long term investments they hold on their balance sheet. Furthermore, RENN has recently taken write-offs on various long term investments, indicating to us that there is some level of adherence to marking down impaired assets.

 

On December 30, 2016, RENN announced that the Special Committee has engaged Duff and Phelps and O'Melveny & Myers LLP as the financial advisor and legal counsel, respectively (see: http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2233132).  

 

On April 6, 2017, RENN announced that it had sold some of its preferred shares in SoFi for net proceeds of $91.9mm and now retains 85.9% of its original stake in SoFi (see http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2260296).

 

So why does this opportunity exist?       

The forced selling due to the unprecedented nature of a public entity spinning off a private equity vehicle has caused RENN’s ADS price to plummet. This provides a margin of safety even if the Special Committee agrees to a low-ball valuation of the long term investments. Renren’s abysmal performance as a public company has led to most major sellside equity research teams to drop coverage.  The confluence of these factors has made RENN an interesting event-driven investment.     

 

Our methodology:    

Our approach was to look at the book value of the long term investments RENN has on its balance sheet and try to use a variety of public sources and conversations with industry connections to understand their respective market values:  

 

 

Note: Unfortunately, specific long term investment data is not reported in the quarterly 6-K filings so there is a discrepancy in the values as from the 20-F filing (FYE 2015, $811.0mm in long term investments) and the most recent 6-K filing (9/30/16, $751.4mm in long term investments). We assume that this $59.6mm decrease in the value in long term investments is due to the disposal of some of the available-for-sale assets and not in relation to a decrease in the value of SoFi or other core VC investments.

 

·         For the investments that are well known Silicon Valley fintech start-ups (SoFi, Fundrise, LendingHome, and Motif Investing, collectively referred to as “core VC investments”) , we looked at public sources and articles, VC valuations from VC databases including Pitchbook and CB Insights, as well as conversations with industry connections in the VC arena.     

·         For the limited partner stake in Kyle Bass’ hedge fund, we assumed that the book value was the market value.

·         For companies that were too obscure to have publicized market valuations, or for companies where we did not know RENN’s percent equity ownership, we took the book value of assets.

 

SoFi / core VC investments valuation analysis:

A large portion of our analysis centers on the valuation of SoFi and developing conviction around its market value. Our estimation of its market value accounts for over 50% of all long term investments’ market value, and from a Q&A call the Company held with shareholders, we know that SoFi is certainly one of the assets that will be spun off into the SpinCo (see: http://media.corporate-ir.net/media_files/IROL/24/244796/Q&A%20Regarding%20Proposed%20Spin-off2.pdf).  

 

Furthermore, from this Q&A, we know that RENN anticipates that “most (by value) of the long term investments on [its] balance sheet will be included in SpinCo for the spin-off, subject to the outcome of negotiations with investors.” It’s important to note that RENN will also be spinning off debt into the SpinCo. The debt that will be spun off is the only debt on RENN’s balance sheet, $97.2mm of which was incurred to invest in SoFi’s series F round.   

 

Lastly, the spin is expected to be completed by the end of the first quarter of 2017.

 

SoFi: SoFi is the second largest marketplace lender in the US and targets the student loan refinancing market. SoFi connects alumni investors to lend money to students from their alma maters (SoFi only focuses on the top 50 universities in the US). Fixed rate loans for students have rates ranging from 5% to 6.6% depending on duration. The company’s board is chaired by Steve Anderson of Baseline Investors which invested in Twitter and Instagram. Directors include Renren’s CEO Joseph Chen, David Chao of DCM (which made VC investment in Renren) and Mike Spence (Nobel Prize in Economics 2011). Executives include senior professional from KKR Financial and Sallie Mae. In addition to RENN, other investors in SoFi include SoftBank (coincidentally, the largest holder of RENN shares, 37% economic interest, 42% voting interest), Silver Lake Partners, Third Point Ventures, Discovery Capital, Institutional Venture Partners, and Wellington Management.

 

Recently, Sofi closed a new round of funding where it raised $452.9mm at a pre-money valuation of $3.9bn (source: Pitchbook). The round was led by Silver Lake Partners and included further investment from SoftBank. Furthermore, financial news outlets have consistently confirmed that SoFi has a private market valuation near $4bn.

 

 

While this set a baseline valuation, we were cautious as the headwinds the online lending industry experienced in 2016 (see: LendingClub’s scandal and Prosper’s difficulties) caused SoFi to pull its 2016 IPO. From our talks with Morgan Stanley’s sellside fintech analyst and our connections within the VC industry, we gained comfort around a $4bn valuation.

 

However, the announcement by RENN on 4/6/17 in regards to their sale of 14.1% of their equity stake in SoFi was a surprise to us. Using RENN’s last disclosed SoFi ownership percentage of 21.2% (from 2015 20-F filing), we backed out that RENN’s sale of 14.1% of their stake in SoFi accounted for approximately 3% of the total value of SoFi. This implies that SoFi has a market value of $3.074.4bn.

 

 

This action taken by RENN was especially surprising to us, as from our understanding, venture investors don’t generally seek to sell stakes especially in such a late round (SoFi’s round G of financing) and when an IPO is expected to occur within the next 12 to 18 months. We speculated that RENN’s sale of some of their stake in SoFi was potentially attributed to two reasons:

 

(1) The core-RENN business is burning cash faster than management expected and it needed additional liquidity.

(2) Management wanted to sell a small stake, at what appears to be a lower-than-market valuation, in an attempt to justify an even lower offer when they must pay out the cash distribution to shareholders unable to hold the private equity vehicle.

 

Note: We recognize that that the $91.9mm that RENN received was net proceeds, not gross proceeds, and there is a ~27% difference between SoFi’s reported pre-money value of ~$4bn and the implied SoFi market value from RENN’s 4/6/17 sale. While RENN likely incurred some taxes on gains and transaction costs, we’re not sure if this would amount to 27% of the sale price. However, to be conservative, we assumed SoFi’s market value is $3.074bn in our following analysis.  

 

Motif Investing: Motif is an online broker that lets investors build thematic portfolios. The company, based in Silicon Valley, is changing the face of online investing through an innovative, transparent social platform that allows individuals and investment advisors to invest in stock and bond portfolios built around everyday ideas and broad economic trends. Motif is a registered broker-dealer and a member of SIPC. The company's investors include Foundation Capital, Goldman Sachs, Ignition Partners and Norwest Venture Partners. At Motif’s latest round of funding in January 2015, the company was valued at $436mm (source: Pitchbook / CB Insights).

 

LendingHome: LendingHome is a mortgage marketplace lender and serves borrowers looking for financing to purchase or refinance residential real estate properties. At the same time, it serves institutional and individual investors looking for access to attractive, high-yield real estate assets. The company has now funded over $1 billion in mortgage loans in the two and a half years since the company launched. Investors in LendingHome include Foundation Capital and First Round Capital. At LendingHome’s latest round of funding in November 2016, the company was valued at $670mm (source: Pitchbook / CB Insights).

 

Fundrise: Fundrise is an online real estate investment crowdfunding platform (E-REIT). Launched in 2012, the company offers real estate investments for both accredited and unaccredited investors, and allows real estate companies to build their investment network and raise investment online through a full service, web-based platform. Fundrise’s most recent round of funding was in September of 2014. Although the valuation at that round is undisclosed, the company has raised a cumulative $40mm to date and is expected to be valued at north of $100mm (source: Pitchbook / CB Insights / Forbes).

 

Scenario and returns analysis:

Unknown variables in this investment center around three questions:

 

(1) Which exact assets with be spun into the SpinCo?

(2) What “illiquidity” haircut will management give on the fair value of assets to determine the cash distribution?

(3) How does the remaining RENN ADS react post-spin?

 

Even as unscrupulous at the management team of Chen and Liu is, we feel that it is relatively safe to assume they will spin the majority, if not all, of the long term investments into the SpinCo. In addition to having stated that this is their intention on the Q&A call, Chen and Liu own 32% economic interest and 49% voting power. Add in SoftBank’s 37% economic interest and 42% voting power you have insiders owning 69% economic interest and 91% voting power. Given that insiders are on a mission to extract as much value as possible from RENN, they are incentivized to spin as many assets as they can out of core-Renren and give as much of a haircut as possible to other shareholders. The fact that RENN disclosed in the 9/30/16 press release that it intended to spin woxiu.com (a core-RENN asset) into the SpinCo gave us confidence in this assertion.   

 

Furthermore, the expectation is that the remaining RENN ADS will significantly decrease post spin. It would not be in management’s best interests to leave valuable assets in core-Renren as it eventually trudges its way to a zero. From our understanding, the reason for the 1-for-5 reverse split is that management expects the RemainCo to immediately fall to the amount of cash per share RENN has on its balance sheet. The reverse split was orchestrated so that each ADR would have a post-spin share price of greater than $1.00, so that the RemainCo would not be delisted.    

 

SCENARIO 1: ACCEPT MANAGEMENT’S CASH OFFER FOR SPINCO

Our first scenario assumes all long term investments are spun into the SpinCo, and the Special Committee agrees to management’s lowball offer valuing the SpinCo at $500mm, net of debt. To be conservative we reduced management’s original $500mm by 14.1%, because we fully expect management to argue that since there is less SoFi, management should now pay less. We arrive at a value of $6.30, which we estimate would be paid out to shareholders unable to hold the SpinCo. It’s important to note that in this scenario, management’s offer is independent of the market valuation of SoFi and other long term investments.

 

To value the RemainCo, we adjusted the cash and short-term investments on RENN’s balance sheet at 9/30/16 and adjusted it for the 4/6/17 SoFi transaction and our estimate of core-RENN’s cash burn since 9/30. To be conservative, we assumed all other RemainCo assets (RENN’s SNS, mobile app, and online lending operations) go to zero. We arrived at a per ADS value of $2.15.

 

Under Scenario 1, we estimate a combined value of $8.44, or 14.4% upside from the current ADS price of $7.38.

 

 

SCENARIO 2: REVISED OFFER FOR SPINCO OR REALIZATION VIA PARTICIPATION IN SPINCO

Whereas our first scenario ignored the market value of SoFi and other long term investments, our second scenario assumes that the cash payment is revised to reflect the market value of these investments. We again assumed that all the long term investments were spun into the SpinCo and that SoFi has a market valuation of $3.1bn. We used the same assumptions as in Scenario 1 to arrive at an estimated RemainCo price per ADS of $2.15.  

 

Under this scenario, we expect management to take some form of an illiquidity discount on the value of the investments in the SpinCo. However, even if management takes a 50% haircut on the value of the investments in the SpinCo, the combined value of the cash payment and the RemainCo ADS would equal $8.96, or 21.4% upside from the current ADS price of $7.38.

 

Of course, if an investor could hold shares in the private equity vehicle and not be subject to illiquidity discount haircuts/lowball valuations (SoFi at a ~$4bn valuation), our analysis shows an investor could potentially get 150%+ returns.  

 

 

Is the core-Renren business worth anything?

Up until this point, we have made the assertion that the core-Renren business is worthless and all non-cash assets in the RemainCo go to zero post spin in each of our scenarios. Regardless, we built an operating model for RENN’s core SNS and online lending business to see if there was any residual value to its core assets.

 

RENN operating metrics: RENN reports two operating metrics: activated user accounts (cumulative total accounts created) and monthly unique log-in users (MAU). Activated user accounts totaled 238mm at 3Q16 and have recently been plateauing. For the past five quarters, YoY growth has been in the low-to-mid single digits. Going forward we projected that this declines to low single digits and the number of activated users plateaus at ~250mm users.

 

MAU entered free fall in 1Q16 where MAU declined YoY (19.6%). For the two subsequent quarters, MAU declined more than 20% YoY. Going forward, we projected that this decline would continue, albeit at a decelerating pace, ultimately leading MAU to decline to 24.6mm.

 

Although the “volume” side of the revenue equation is declining for RENN, the “price” side of the equation seemed to have gotten a second wind in 2Q16 & 3Q16 where advertising and IVAS net revenue per MAU increased 9.8% and 68.4% YoY, respectively. This was due to a pickup in woxiu.com revenue and the new RENN mobile livestreaming revenue which began in 2Q16. Financing income from RENN’s online lending business is also ramping up.

 

Given this unique dynamic of increasing revenue per MAU, but declining overall MAU, we thought it would be a prudent exercise to see if RENN can rapidly monetize a shrinking MAU user base and turn a profit before it runs out of liquidity (note: as of 3Q16 RENN had $72.0mm of cash and cash equivalents). We wanted to see if there were any near term liquidity issues that may put the proposed transaction in jeopardy. RENN has not been operating income positive for the last eight quarters. RENN’s COGS as a percent of revenues over the last eight quarters averages ~86%. In 4Q15, COGS even rose to over 100% of revenues leading RENN to be gross profit negative that quarter.

 

Going forward we assumed a fixed 20% gross margin and slight decreases in the operating expense line items as a percentage of revenue to give RENN slight operating leverage.

 

Unfortunately for RENN, the net loss continues to widen due to an inability to monetize MAU faster than MAU decline. The core-Renren business continues to be operating cash flow negative and burns cash until 4Q17, at which point it must seek outside financing. The good news is there seems to be enough excess cash to give RENN breathing room to execute the proposed transaction. The bad news is that we don’t believe the core-Renren business has any real value.      

 

Additional concerns and concluding thoughts:

Ideally, this investment would be best suited for accredited investors and investment funds with flexible mandates to hold illiquid investments. The best way to ensure a greater margin of safety in this investment is to put oneself in the same position as Chen, Liu, and SoftBank (i.e. hold on to the SpinCo and realize value as the investments IPO or are sold). If an investor were able to do this, he or she would not have to argue over the market value of SoFi and over what is a reasonable illiquidity discount.  Furthermore, an investor who is able to hold the SpinCo shares also benefits from being able to own a stake in SoFi at a much earlier valuation.

    

However, given our primary research and discussions with industry professionals, we know that Joseph Chen is unscrupulous, cunning, and has zero regard for minority shareholders. If one is to enter this investment at all, one needs to go in expecting to take the cash distribution and NOT expect to hold shares in the SpinCo.

 

RENN is incorporated under Cayman law, which allows majority shareholder/insiders vote on corporate matters. Furthermore, the SpinCo will likely be incorporated under Cayman law as well. There is no assurance that Joseph Chen and SoftBank will not seek to squeeze out minority shareholders in SpinCo to further steal value. Also, even if an investor were able to hold the SpinCo, there is no guarantee that Chen, Liu, and SoftBank would distribute any proceeds from a potential SoFi IPO in a timely manner.  

 

While we believe that there is immense value locked within RENN, structural and governance hurdles make potential multi-bagger returns very unlikely. However, even using very conservative assumptions, we can see that a 14.4% to 21.4% return is achievable even in the most draconic scenarios.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts to realize value:

·         Additional information: Much of the returns and scenario analysis is centered on what management may or may not do.  Information regarding the proposed transaction, definitively what assets will be included in the SpinCo, and valuation practices in determining the cash payment will help narrow the scope of our analysis.

·         Favorable valuation of illiquid investments:  Duff and Phelps arrives at a reasonable valuation for the long term assets. Management proposes a reasonable haircut on the valuation.

·         A look into SoFi’s books: SoFi filing a public S-1 would give the market conviction on SoFi’s value in a potential IPO.

o    This also reduces the ability of RENN management to give unsubstantiated low-ball offers on the cash distribution payment

·         Better-than-expected core-Renren business: Stabilizing the decline of MAU and successfully executing a turnaround of core-Renren operations would give the investment an increased margin of safety and longer timeline to complete the deal even if it is delayed.

 

Risks to the downside:

·         The Special Committee is not independent and agrees to the absurdly low valuation of the SpinCo

o    Markets capitulates more than it already has and the shares plummet further because, while there indeed is real value in RENN’s long term investments, the dysfunction between management and shareholders may never result in the value being unlocked  

·         Delay in transaction leading core-Renren business to face liquidity issues, forcing management to sell long term investments at fire sale prices

·         RENN is not able to execute a spin-off and is in violation of the Investment Company Act of 1940, leading to an inability to comply with reporting obligation and an eventual delisting form the NYSE.

o    However, should this delisting happen, it may be an even greater opportunity to purchase shares as many funds do not have it within their mandate to hold OTC stocks.

 

Additional questions:

·         What are the tax implications of the proposed spin-off transaction?

o    RENN has stated that it intends for such distribution to qualify, for U.S. tax purposes, as a tax-free distribution to the Company's U.S. shareholders who receive shares of SpinCo in the distribution.

o    However, are there unforeseen implications that could derail the proposed transaction?     

·         Will there be a shareholder vote / proxy on the transaction or will it come down to the “independent” board accepting a valuation from management and SoftBank?

·         What entity will pay the cash distribution?

o    We expect that the SpinCo will take on leverage to pay the cash distribution to non-accredited investors and other investors who elect to receive the cash payment instead of the shares in the SpinCo.

 

·         How onerous would it actually be for RENN to obtain exemptive relief from the SEC and avoid being classified as an investment company?

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    Description

     

     

    Note: Renren recently underwent a 1-for-5 reverse split in its US-listed ADS on 2/6/17. Each ADS now represents 15 ordinary shares. For the purpose of this investment write-up, all calculations will be in ADS.

    We are recommending a long position in Renren Inc. (NYSE: RENN, “Renren”, “the Company”) for the following reasons:

    (1)     Abysmal deterioration of core-Renren business clouds the significant value of the long term investments Renren has made over the years, providing optionality and margin of safety

    (2)     Unique situation of a public entity spinning out a private equity vehicle causes both institutional and retail shareholders to be unable to hold shares in aforementioned private equity vehicle, which has caused the shares to sell off, offering attractive entry price

    (3)     Large insider ownership by a management team that is also incentivized to strip assets (more on why this a good thing later)

    (4)     Near-term catalyst where investment is expected to return between 14.4% and 21.4% within the next two quarters

     

    Background:

    Renren (NYSE: RENN) operates a real-name social networking service (SNS) and an internet finance business in China. The Company IPO’d in May of 2011 to much fanfare. At the time Renren was hyped as the Facebook (real-name SNS), Zynga (mobile / social gaming), YouTube (user-generated video content), and Groupon (group-buying business) of China. In May of 2011, Renren was able to raise $740mm in an IPO where 53.1mm shares priced at $14 then rose to $20+ in the first day of trading. At the time the business had a market cap north of $7bn. Fast forward to 2017, RENN has since sold off its Zynga, YouTube, and Groupon-like businesses. And after a several quarters of earnings misses, inability to grow RENN’s SNS business beyond its initial user base of college students, and accelerating decline in MAU, the core RENN business looks like it’s headed towards a zero. On a pre-reverse split basis, each ADS currently trades at $1.48, some 93% lower than its ~$20 highs and only 0.4% above its all-time low of $1.47.

     

    Now, while Joseph Chen has been an excellent destroyer of shareholder value, he has been quite successful moonlighting as a VC investor. A quick look at RENN’s balance sheet shows the multitude of investments that management has made over the years including significant stakes in notable fintech start-ups (SoFi, Fundrise, LendingHome, and Motif Investing) to limited partnership stakes in macro hedge funds (Kyle Bass’ Hayman Capital). As of the quarter ending 9/30/16 (last available data), RENN held $751.4mm of long term investments on its balance sheet.

     

    This figure, which we believe to be conservative due to the fact that RENN does equity method accounting for several of its investments, is already greater than RENN’s current total enterprise value of $503.5mm (using last available balance sheet data from 9/30/16). If one nets out these investments, the core-Renren business is attributed a negative total enterprise value of (~$200mm+).

     

    Situation update:

    We believe RENN management is well aware that their core business is headed towards a zero. The core business is unlikely to ever turn a profit. The number of activated user accounts has plateaued around 230mm. MAU has entered free fall and has been declining YoY at ~20% for the past three quarters. Loss margins are widening. Given that management is aware that they are at the end of the road, we believe management is on a quest to strip RENN of its long term investments from general shareholders in an attempt to enrich themselves.

     

    In June of 2015, RENN CEO Joseph Chen and COO James Jian Liu made a preliminary non-binding going-private proposal to the RENN board to buy all outstanding ADS for $4.20 (pre-reverse split price) each (http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2058147).

     

    This represented approximately a 22% premium to the average closing share price to the RENN ADS over the previous month. At the time, Chen and Liu beneficially owned 32% of the ordinary shares representing 49% voting power.

     

    Cue the uproar. Soon afterwards, institutional shareholders were furious and saw this proposal as a blatant attempt to steal value from shareholders (see: http://www.prnewswire.com/news-releases/open-letter-to-renren-special-committee-board-of-directors-and-all-renren-shareholders-from-private-investors-300149119.html). Angry shareholders argued that the offer price significantly undervalued the RENN on a SOTP basis and management was negotiating in bad faith.

     

    Given the outstanding take-private offer, RENN stopped giving guidance in earning releases and stop holding conference calls post earnings. To date, the take-private offer has neither been accepted nor rejected, and RENN has neither given guidance nor held a conference call since the initial offer was made in June 2015.

    What is interesting is that in the 20-F filing (10-K equivalent) for FYE 2015, new language emerged in the “Risks Related to Our Business and Industry” section. Specifically, language regarding the Investment Company Act of 1940 was added, whereas it had not been in previous 20-F filings.

     

    From the filing:

    If we are deemed an “investment company” under the Investment Company Act of 1940, it would adversely affect the price of our ADSs and ordinary shares and could have a material adverse effect on our business.

    Our assets include a 21.2% interest in Social Finance Inc., a 20.0% interest in 268V Limited, a 14.7% interest in Lending Home Corporation, a 29.0% interest in Trucker Path Inc. and a 25.3% interest in Rise Companies Corp. These and other investments that we have made may be deemed to be “investment securities” within the meaning of the Investment Company Act of 1940, as amended. As a foreign private issuer, we would not be eligible to register under the Investment Company Act, so if we are deemed to be an investment company within the meaning of the Investment Company Act, we would either have to obtain exemptive relief from the SEC, modify our contractual rights or dispose of investments in order to fall outside the definition of an investment company. Additionally, we may have to forego potential future acquisitions of interests in companies that may be deemed to be investment securities within the meaning of the Investment Company Act. Failure to avoid being deemed an investment company under the Investment Company Act coupled with our inability as a foreign private issuer to register under the Investment Company Act could make us unable to comply with our reporting obligations as a public company in the United States and lead to our being delisted from the New York Stock Exchange, which would have a material adverse effect on the liquidity and value of our ADSs and Class A ordinary shares.

     

    On September 30, 2016, RENN announced that it intends to “spin off a newly formed subsidiary ("SpinCo") that will hold the Company's social video platform woxiu.com and most of the Company's investments in minority stakes in privately held companies” (see: http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2207071).

     

    From the press release (emphasis added):

    The spin-off is being undertaken to minimize the risk that the Company could be deemed to be an "investment company" under the Investment Company Act of 1940 by reducing the aggregate amount of investments in unconsolidated subsidiaries on the Company's balance sheet and to unlock potential in the Company's social video business by separating it from the Company's social networking and internet financing businesses.

     

    The Company plans to distribute rights, exercisable for shares in SpinCo, to the Company's shareholders on a pro rata basis. The rights will not be transferable and may only be exercised by shareholders who are both "qualified purchasers" under the Investment Company Act of 1940 and "accredited investors" under the Securities Exchange Act of 1934. The Company will distribute cash in lieu of fractional rights and cash to holders of rights who cannot exercise or who choose not to exercise their rights.

     

    The Company plans to distribute no less than 80% of the shares of SpinCo to shareholders that exercise rights and intends for such distribution to qualify, for U.S. tax purposes, as a tax-free distribution to the Company's U.S. shareholders who receive shares of SpinCo in the distribution.

     

    Following the spin-off, SpinCo will be a privately held company not subject to public company reporting requirements under the Securities Exchange Act of 1934 and not listed on any stock exchange. The Company intends to remain a public company listed on the New York Stock Exchange.

     

    The Company will announce further details at a later date, including the record date for the rights distribution, the ratio of shares of the Company to rights, the distribution date for the rights distribution, the deadline for the exercise of the rights, and the date on which shares of SpinCo and/or cash will be distributed to holders of rights.

     

    We view this as an extremely cunning play by management. It’s almost unheard of where a public entity spins off a private equity vehicle, but by coming up with this novel transaction, management has effectively created a win-win situation for themselves. Large institutional shareholders are likely unable to hold a private equity-like vehicle and have undergone forced selling. The majority of retail investors are unlikely to be accredited investors and have similarly undergone forced selling. The market initially reacted positively to the news and RENN ADS rose to $12.35 (post-reverse split price) but after digesting the information, the ADS have continued to sell off to $7.38 today (~40% sell off). This forced selling is driving down the price of RENN shares potentially giving management the opportunity to pick them up at a discount.     

     

    On December 5, 2016, RENN announced the appointment of two new independent directors, Stephen Tappin and Tianruo Pu (see: http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2227368).

     

    Then, just a few weeks later on December 22, 2016, RENN announced that it had formed a Special Committee to review the terms of the proposed spin-off. The three board members appointed to the Special Committee are Hui Huang, Stephen Tappin, and Tianruo Pu (see: http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2231339).

     

    Claim that a legal regulation is forcing you to spin out the valuable assets, and then stack the deck. Cue maniacal laugh.

     

    Unfortunately, due to the recent appointment of Tappin and Pu to the board, there has not been a 20-F filing that has detailed their compensation. Hui Huang on the other hand has been a director since January 2015. Although her exact compensation as a board member is not disclosed in 20-F filing, it does indicate that her aggregate beneficial ownership of RENN is less than 1% of total outstanding shares.

     

    RENN also disclosed in this press release that the board had received another nonbinding proposal from Chen and Liu (emphasis added):

     

    The Company further announced that its board of directors has received a preliminary non-binding proposal to purchase any shares of SpinCo that are not distributed in the proposed spin-off. The letter was from Mr. Joseph Chen, the Company's founder, chairman and chief executive officer, Mr. James Jian Liu, the Company's executive director and chief operating officer, and SoftBank Group Capital Limited, an affiliate of SB Pan Pacific Corporation. Mr. Chen and SB Pan Pacific Corporation are the Company's two largest shareholders. The preliminary non-binding proposal would value SpinCo at US$500 million, net of debt.

     

    We view this as an absurdly low offer to purchase remaining undistributed shares of the SpinCo by Chen, Liu, and SoftBank. This offer is lower than the book value of all of RENN’s long term investments, $751.4mm, and our estimation of just RENN’s stake in SoFi’s market value of $753.8mm. And while it can be argued that book values do not always reflect true mark-to-market values, we don’t believe that argument applies here. Management has a clear incentive to understate the values of the long term investments they hold on their balance sheet. Furthermore, RENN has recently taken write-offs on various long term investments, indicating to us that there is some level of adherence to marking down impaired assets.

     

    On December 30, 2016, RENN announced that the Special Committee has engaged Duff and Phelps and O'Melveny & Myers LLP as the financial advisor and legal counsel, respectively (see: http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2233132).  

     

    On April 6, 2017, RENN announced that it had sold some of its preferred shares in SoFi for net proceeds of $91.9mm and now retains 85.9% of its original stake in SoFi (see http://ir.renren-inc.com/phoenix.zhtml?c=244796&p=irol-newsArticle&ID=2260296).

     

    So why does this opportunity exist?       

    The forced selling due to the unprecedented nature of a public entity spinning off a private equity vehicle has caused RENN’s ADS price to plummet. This provides a margin of safety even if the Special Committee agrees to a low-ball valuation of the long term investments. Renren’s abysmal performance as a public company has led to most major sellside equity research teams to drop coverage.  The confluence of these factors has made RENN an interesting event-driven investment.     

     

    Our methodology:    

    Our approach was to look at the book value of the long term investments RENN has on its balance sheet and try to use a variety of public sources and conversations with industry connections to understand their respective market values:  

     

     

    Note: Unfortunately, specific long term investment data is not reported in the quarterly 6-K filings so there is a discrepancy in the values as from the 20-F filing (FYE 2015, $811.0mm in long term investments) and the most recent 6-K filing (9/30/16, $751.4mm in long term investments). We assume that this $59.6mm decrease in the value in long term investments is due to the disposal of some of the available-for-sale assets and not in relation to a decrease in the value of SoFi or other core VC investments.

     

    ·         For the investments that are well known Silicon Valley fintech start-ups (SoFi, Fundrise, LendingHome, and Motif Investing, collectively referred to as “core VC investments”) , we looked at public sources and articles, VC valuations from VC databases including Pitchbook and CB Insights, as well as conversations with industry connections in the VC arena.     

    ·         For the limited partner stake in Kyle Bass’ hedge fund, we assumed that the book value was the market value.

    ·         For companies that were too obscure to have publicized market valuations, or for companies where we did not know RENN’s percent equity ownership, we took the book value of assets.

     

    SoFi / core VC investments valuation analysis:

    A large portion of our analysis centers on the valuation of SoFi and developing conviction around its market value. Our estimation of its market value accounts for over 50% of all long term investments’ market value, and from a Q&A call the Company held with shareholders, we know that SoFi is certainly one of the assets that will be spun off into the SpinCo (see: http://media.corporate-ir.net/media_files/IROL/24/244796/Q&A%20Regarding%20Proposed%20Spin-off2.pdf).  

     

    Furthermore, from this Q&A, we know that RENN anticipates that “most (by value) of the long term investments on [its] balance sheet will be included in SpinCo for the spin-off, subject to the outcome of negotiations with investors.” It’s important to note that RENN will also be spinning off debt into the SpinCo. The debt that will be spun off is the only debt on RENN’s balance sheet, $97.2mm of which was incurred to invest in SoFi’s series F round.   

     

    Lastly, the spin is expected to be completed by the end of the first quarter of 2017.

     

    SoFi: SoFi is the second largest marketplace lender in the US and targets the student loan refinancing market. SoFi connects alumni investors to lend money to students from their alma maters (SoFi only focuses on the top 50 universities in the US). Fixed rate loans for students have rates ranging from 5% to 6.6% depending on duration. The company’s board is chaired by Steve Anderson of Baseline Investors which invested in Twitter and Instagram. Directors include Renren’s CEO Joseph Chen, David Chao of DCM (which made VC investment in Renren) and Mike Spence (Nobel Prize in Economics 2011). Executives include senior professional from KKR Financial and Sallie Mae. In addition to RENN, other investors in SoFi include SoftBank (coincidentally, the largest holder of RENN shares, 37% economic interest, 42% voting interest), Silver Lake Partners, Third Point Ventures, Discovery Capital, Institutional Venture Partners, and Wellington Management.

     

    Recently, Sofi closed a new round of funding where it raised $452.9mm at a pre-money valuation of $3.9bn (source: Pitchbook). The round was led by Silver Lake Partners and included further investment from SoftBank. Furthermore, financial news outlets have consistently confirmed that SoFi has a private market valuation near $4bn.

     

     

    While this set a baseline valuation, we were cautious as the headwinds the online lending industry experienced in 2016 (see: LendingClub’s scandal and Prosper’s difficulties) caused SoFi to pull its 2016 IPO. From our talks with Morgan Stanley’s sellside fintech analyst and our connections within the VC industry, we gained comfort around a $4bn valuation.

     

    However, the announcement by RENN on 4/6/17 in regards to their sale of 14.1% of their equity stake in SoFi was a surprise to us. Using RENN’s last disclosed SoFi ownership percentage of 21.2% (from 2015 20-F filing), we backed out that RENN’s sale of 14.1% of their stake in SoFi accounted for approximately 3% of the total value of SoFi. This implies that SoFi has a market value of $3.074.4bn.

     

     

    This action taken by RENN was especially surprising to us, as from our understanding, venture investors don’t generally seek to sell stakes especially in such a late round (SoFi’s round G of financing) and when an IPO is expected to occur within the next 12 to 18 months. We speculated that RENN’s sale of some of their stake in SoFi was potentially attributed to two reasons:

     

    (1) The core-RENN business is burning cash faster than management expected and it needed additional liquidity.

    (2) Management wanted to sell a small stake, at what appears to be a lower-than-market valuation, in an attempt to justify an even lower offer when they must pay out the cash distribution to shareholders unable to hold the private equity vehicle.

     

    Note: We recognize that that the $91.9mm that RENN received was net proceeds, not gross proceeds, and there is a ~27% difference between SoFi’s reported pre-money value of ~$4bn and the implied SoFi market value from RENN’s 4/6/17 sale. While RENN likely incurred some taxes on gains and transaction costs, we’re not sure if this would amount to 27% of the sale price. However, to be conservative, we assumed SoFi’s market value is $3.074bn in our following analysis.  

     

    Motif Investing: Motif is an online broker that lets investors build thematic portfolios. The company, based in Silicon Valley, is changing the face of online investing through an innovative, transparent social platform that allows individuals and investment advisors to invest in stock and bond portfolios built around everyday ideas and broad economic trends. Motif is a registered broker-dealer and a member of SIPC. The company's investors include Foundation Capital, Goldman Sachs, Ignition Partners and Norwest Venture Partners. At Motif’s latest round of funding in January 2015, the company was valued at $436mm (source: Pitchbook / CB Insights).

     

    LendingHome: LendingHome is a mortgage marketplace lender and serves borrowers looking for financing to purchase or refinance residential real estate properties. At the same time, it serves institutional and individual investors looking for access to attractive, high-yield real estate assets. The company has now funded over $1 billion in mortgage loans in the two and a half years since the company launched. Investors in LendingHome include Foundation Capital and First Round Capital. At LendingHome’s latest round of funding in November 2016, the company was valued at $670mm (source: Pitchbook / CB Insights).

     

    Fundrise: Fundrise is an online real estate investment crowdfunding platform (E-REIT). Launched in 2012, the company offers real estate investments for both accredited and unaccredited investors, and allows real estate companies to build their investment network and raise investment online through a full service, web-based platform. Fundrise’s most recent round of funding was in September of 2014. Although the valuation at that round is undisclosed, the company has raised a cumulative $40mm to date and is expected to be valued at north of $100mm (source: Pitchbook / CB Insights / Forbes).

     

    Scenario and returns analysis:

    Unknown variables in this investment center around three questions:

     

    (1) Which exact assets with be spun into the SpinCo?

    (2) What “illiquidity” haircut will management give on the fair value of assets to determine the cash distribution?

    (3) How does the remaining RENN ADS react post-spin?

     

    Even as unscrupulous at the management team of Chen and Liu is, we feel that it is relatively safe to assume they will spin the majority, if not all, of the long term investments into the SpinCo. In addition to having stated that this is their intention on the Q&A call, Chen and Liu own 32% economic interest and 49% voting power. Add in SoftBank’s 37% economic interest and 42% voting power you have insiders owning 69% economic interest and 91% voting power. Given that insiders are on a mission to extract as much value as possible from RENN, they are incentivized to spin as many assets as they can out of core-Renren and give as much of a haircut as possible to other shareholders. The fact that RENN disclosed in the 9/30/16 press release that it intended to spin woxiu.com (a core-RENN asset) into the SpinCo gave us confidence in this assertion.   

     

    Furthermore, the expectation is that the remaining RENN ADS will significantly decrease post spin. It would not be in management’s best interests to leave valuable assets in core-Renren as it eventually trudges its way to a zero. From our understanding, the reason for the 1-for-5 reverse split is that management expects the RemainCo to immediately fall to the amount of cash per share RENN has on its balance sheet. The reverse split was orchestrated so that each ADR would have a post-spin share price of greater than $1.00, so that the RemainCo would not be delisted.    

     

    SCENARIO 1: ACCEPT MANAGEMENT’S CASH OFFER FOR SPINCO

    Our first scenario assumes all long term investments are spun into the SpinCo, and the Special Committee agrees to management’s lowball offer valuing the SpinCo at $500mm, net of debt. To be conservative we reduced management’s original $500mm by 14.1%, because we fully expect management to argue that since there is less SoFi, management should now pay less. We arrive at a value of $6.30, which we estimate would be paid out to shareholders unable to hold the SpinCo. It’s important to note that in this scenario, management’s offer is independent of the market valuation of SoFi and other long term investments.

     

    To value the RemainCo, we adjusted the cash and short-term investments on RENN’s balance sheet at 9/30/16 and adjusted it for the 4/6/17 SoFi transaction and our estimate of core-RENN’s cash burn since 9/30. To be conservative, we assumed all other RemainCo assets (RENN’s SNS, mobile app, and online lending operations) go to zero. We arrived at a per ADS value of $2.15.

     

    Under Scenario 1, we estimate a combined value of $8.44, or 14.4% upside from the current ADS price of $7.38.

     

     

    SCENARIO 2: REVISED OFFER FOR SPINCO OR REALIZATION VIA PARTICIPATION IN SPINCO

    Whereas our first scenario ignored the market value of SoFi and other long term investments, our second scenario assumes that the cash payment is revised to reflect the market value of these investments. We again assumed that all the long term investments were spun into the SpinCo and that SoFi has a market valuation of $3.1bn. We used the same assumptions as in Scenario 1 to arrive at an estimated RemainCo price per ADS of $2.15.  

     

    Under this scenario, we expect management to take some form of an illiquidity discount on the value of the investments in the SpinCo. However, even if management takes a 50% haircut on the value of the investments in the SpinCo, the combined value of the cash payment and the RemainCo ADS would equal $8.96, or 21.4% upside from the current ADS price of $7.38.

     

    Of course, if an investor could hold shares in the private equity vehicle and not be subject to illiquidity discount haircuts/lowball valuations (SoFi at a ~$4bn valuation), our analysis shows an investor could potentially get 150%+ returns.  

     

     

    Is the core-Renren business worth anything?

    Up until this point, we have made the assertion that the core-Renren business is worthless and all non-cash assets in the RemainCo go to zero post spin in each of our scenarios. Regardless, we built an operating model for RENN’s core SNS and online lending business to see if there was any residual value to its core assets.

     

    RENN operating metrics: RENN reports two operating metrics: activated user accounts (cumulative total accounts created) and monthly unique log-in users (MAU). Activated user accounts totaled 238mm at 3Q16 and have recently been plateauing. For the past five quarters, YoY growth has been in the low-to-mid single digits. Going forward we projected that this declines to low single digits and the number of activated users plateaus at ~250mm users.

     

    MAU entered free fall in 1Q16 where MAU declined YoY (19.6%). For the two subsequent quarters, MAU declined more than 20% YoY. Going forward, we projected that this decline would continue, albeit at a decelerating pace, ultimately leading MAU to decline to 24.6mm.

     

    Although the “volume” side of the revenue equation is declining for RENN, the “price” side of the equation seemed to have gotten a second wind in 2Q16 & 3Q16 where advertising and IVAS net revenue per MAU increased 9.8% and 68.4% YoY, respectively. This was due to a pickup in woxiu.com revenue and the new RENN mobile livestreaming revenue which began in 2Q16. Financing income from RENN’s online lending business is also ramping up.

     

    Given this unique dynamic of increasing revenue per MAU, but declining overall MAU, we thought it would be a prudent exercise to see if RENN can rapidly monetize a shrinking MAU user base and turn a profit before it runs out of liquidity (note: as of 3Q16 RENN had $72.0mm of cash and cash equivalents). We wanted to see if there were any near term liquidity issues that may put the proposed transaction in jeopardy. RENN has not been operating income positive for the last eight quarters. RENN’s COGS as a percent of revenues over the last eight quarters averages ~86%. In 4Q15, COGS even rose to over 100% of revenues leading RENN to be gross profit negative that quarter.

     

    Going forward we assumed a fixed 20% gross margin and slight decreases in the operating expense line items as a percentage of revenue to give RENN slight operating leverage.

     

    Unfortunately for RENN, the net loss continues to widen due to an inability to monetize MAU faster than MAU decline. The core-Renren business continues to be operating cash flow negative and burns cash until 4Q17, at which point it must seek outside financing. The good news is there seems to be enough excess cash to give RENN breathing room to execute the proposed transaction. The bad news is that we don’t believe the core-Renren business has any real value.      

     

    Additional concerns and concluding thoughts:

    Ideally, this investment would be best suited for accredited investors and investment funds with flexible mandates to hold illiquid investments. The best way to ensure a greater margin of safety in this investment is to put oneself in the same position as Chen, Liu, and SoftBank (i.e. hold on to the SpinCo and realize value as the investments IPO or are sold). If an investor were able to do this, he or she would not have to argue over the market value of SoFi and over what is a reasonable illiquidity discount.  Furthermore, an investor who is able to hold the SpinCo shares also benefits from being able to own a stake in SoFi at a much earlier valuation.

        

    However, given our primary research and discussions with industry professionals, we know that Joseph Chen is unscrupulous, cunning, and has zero regard for minority shareholders. If one is to enter this investment at all, one needs to go in expecting to take the cash distribution and NOT expect to hold shares in the SpinCo.

     

    RENN is incorporated under Cayman law, which allows majority shareholder/insiders vote on corporate matters. Furthermore, the SpinCo will likely be incorporated under Cayman law as well. There is no assurance that Joseph Chen and SoftBank will not seek to squeeze out minority shareholders in SpinCo to further steal value. Also, even if an investor were able to hold the SpinCo, there is no guarantee that Chen, Liu, and SoftBank would distribute any proceeds from a potential SoFi IPO in a timely manner.  

     

    While we believe that there is immense value locked within RENN, structural and governance hurdles make potential multi-bagger returns very unlikely. However, even using very conservative assumptions, we can see that a 14.4% to 21.4% return is achievable even in the most draconic scenarios.

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Catalysts to realize value:

    ·         Additional information: Much of the returns and scenario analysis is centered on what management may or may not do.  Information regarding the proposed transaction, definitively what assets will be included in the SpinCo, and valuation practices in determining the cash payment will help narrow the scope of our analysis.

    ·         Favorable valuation of illiquid investments:  Duff and Phelps arrives at a reasonable valuation for the long term assets. Management proposes a reasonable haircut on the valuation.

    ·         A look into SoFi’s books: SoFi filing a public S-1 would give the market conviction on SoFi’s value in a potential IPO.

    o    This also reduces the ability of RENN management to give unsubstantiated low-ball offers on the cash distribution payment

    ·         Better-than-expected core-Renren business: Stabilizing the decline of MAU and successfully executing a turnaround of core-Renren operations would give the investment an increased margin of safety and longer timeline to complete the deal even if it is delayed.

     

    Risks to the downside:

    ·         The Special Committee is not independent and agrees to the absurdly low valuation of the SpinCo

    o    Markets capitulates more than it already has and the shares plummet further because, while there indeed is real value in RENN’s long term investments, the dysfunction between management and shareholders may never result in the value being unlocked  

    ·         Delay in transaction leading core-Renren business to face liquidity issues, forcing management to sell long term investments at fire sale prices

    ·         RENN is not able to execute a spin-off and is in violation of the Investment Company Act of 1940, leading to an inability to comply with reporting obligation and an eventual delisting form the NYSE.

    o    However, should this delisting happen, it may be an even greater opportunity to purchase shares as many funds do not have it within their mandate to hold OTC stocks.

     

    Additional questions:

    ·         What are the tax implications of the proposed spin-off transaction?

    o    RENN has stated that it intends for such distribution to qualify, for U.S. tax purposes, as a tax-free distribution to the Company's U.S. shareholders who receive shares of SpinCo in the distribution.

    o    However, are there unforeseen implications that could derail the proposed transaction?     

    ·         Will there be a shareholder vote / proxy on the transaction or will it come down to the “independent” board accepting a valuation from management and SoftBank?

    ·         What entity will pay the cash distribution?

    o    We expect that the SpinCo will take on leverage to pay the cash distribution to non-accredited investors and other investors who elect to receive the cash payment instead of the shares in the SpinCo.

     

    ·         How onerous would it actually be for RENN to obtain exemptive relief from the SEC and avoid being classified as an investment company?

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