|Shares Out. (in M):||1,103||P/E||0.0x||0.0x|
|Market Cap (in $M):||1,700||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||1,131||EBIT||0||0|
Renren Inc (NYSE: RENN) is a broken Chinese Internet IPO that was once hyped as China’s Facebook, Zynga, YouTube and Groupon all in one company. The company sold 53.1 mm ADS shares at $14 per share in May 2011, and the shares opened at $19.5 on the day of IPO. Then after a few quarters of earnings misses and due to concerns over its ability to monetize mobile traffic, RENN dropped to a low of $3.
The stock trades at $4.48 currently.
We have had this write up on deck for weeks—and have been waiting for a decline in order to post it--but this is an M&A target and it’s run up.
Despite the appreciation, it’s still interesting because a) there’s significant downside protection, b) there’s meaningful optionality, c) there’s M&A interest in the sector, and d) we have strong management that has been very aggressive on their buyback. We do not know if it’s heading back down to $3.50 or on the way to a buyout at $6+, but we are posting it so it’s on the radar of the VIC community. There may be a bunch of momentum players that just got into the stock, and if nothing happens in the next month, this is going back to the mid 3’s at which point it’s very interesting again.
As of Q3 2013, 80% of Renren.com’s social networking traffic comes from mobile (2010: 20%, 2011: 54%, 2012: 69%), but only 10% advertising revenue comes from mobile. In Q3 2013, the company reported the first revenue decline since going public due to traffic migration to mobile and the lack of mobile monetization. Most Internet analysts have abandoned RENN, favoring more glamorous stocks like Tencent Holdings (HK 700) which owns the fast growing WeChat messaging app or SINA which owns China’s microblogging service Weibo.
We think of RENN as a mispriced option abandoned by the public. Although we are not fans of “valuation per eyeball” type of metrics, RENN’s valuation gap between both Chinese and US counterparts is very large while the cash on the balance sheet provides good downside protection. Management has already bought back $150 mm of stock since 2011 and is currently executing the second, $100 mm share repurchase authorization. Joseph Chen, CEO and founder of RENN who often quotes Buffett in explaining his decisions, openly recognized the cash balance and depressed share price as reasons for buying back stock.
Equity structure and insiders
The company has Class A and Class B shares. There are 791 mm A shares and 305 mm B shares. Class B shares can be converted into Class A shares on a one-on-one basis. Both Class A and Class B shares are referred to as ordinary shares. A shares have one vote per share, and B shares have ten votes per share. Each ADR share represents three Class A shares. Only Chen and Softbank hold the B shares.
Initial investors in Renren include Softbank, General Atlantic and VC firm DCM. Softbank still holds 37% economic interest and 42% voting interest in the company. General Atlantic invested in Renren, exited in 2012 but still has a director on Renren’s board. DCM owns 8.2% economic interest and their GP David Chao sits on the board. Joe Chen and his parents moved to the US in early 90’s and he studied physics at University of Delaware as an undergrad. He then obtained an engineering degree from MIT and an MBA degree from Stanford. Joe Chen owns 25% economic interest and 47% voting interest. Other RENN executives were educated at Stanford, Wharton and Tsinghua (China’s top university). Insiders including Softbank own about 73% economic interest and 92% voting interest in the company.
You can watch this video to learn more about Joseph Chen: http://video.mit.edu/watch/lessons-from-china-joe-chen-mit-club-of-northern-california-11093/
RENN operates three major digital assets:
(1) Renren.com, the dominant real-name, Facebook-like social networking website in China with 200 million registered users and 50 million monthly unique users, primarily teenagers and young people in their 20s.
(2) 56.com, a second-tier video website focused on User Generated Content (UGC) with about 100 million monthly active users. RENN bought 56.com in Q4 2011 at a depressed value of $80 mm in cash. At that time, short-sellers were targeting Chinese companies listed in the US and two bigger Chinese video websites Youku and Tudou went public (Youku later acquired Tudou) before 56.com, diminishing its odds of an IPO. In Q3 2013, 56.com’s daily unique visitors increased 80% y/y and contributed about $3 mm of advertising revenue. For the past two years, Renren has been nurturing the user base on 56 and has just started monetizing 56’s mobile traffic. 56 also operates Woxiu, a virtual stage where grassroots musicians and performers (mainly girls) can live-stream their performances and fans purchase virtual items to show support. A close comp is YY (NASDAQ:YY). In Q2 2013, this business generated about $3.5 mm revenue. To understand the need for businesses like Woxiu and YY, Western investors need to understand the social dynamics in China – there are a lot of single, lower-to-middle class young men working in large cities and away from their hometown. There is a shortage of girls due to the long-standing culture of favoring boys. DeNA, one of Japan’s largest game developers, also recently entered this business.
(3) A games development business that makes games for both Renren.com (think Farmville) and Apple/Android devices. At the end of Q3 2013, the company had 51 third-party games and 16 in-house games. All top 5 games are in-house games. In 2012, top five games contributed to 68% of total online games revenue, or 35% of total corporate revenue.
In October 2013 the company sold 59% stake of Nuomi, a major group-buying business like Groupon to Baidu (the dominant search engine in China) for $160 mm.
RENN’s original intention was to keep the remaining stake and account for it using the equity method, while continuing building out the business with Baidu. There were rumors that Baidu would eventually IPO part of Nuomi. Curiously, three short months after the close of the deal, RENN sold the remaining stake to Baidu for an undisclosed amount. Given the short time period between the two deals, we think it is reasonable to assign the rest of the stake $108 mm using the valuation of the first piece. In 2012, Nuomi contributed 9% revenue but contributed 30% of 2012 operating losses.
Pro forma of the expected $108 mm from the second Nuomi piece and our estimated Q4 cash burn, about 65% of RENN’s market cap today is in cash, most of which from the May 2011 IPO and kept in offshore USD accounts.
Term deposits 410
Short-term investments 309
First Nuomi deal 160
Second Nuomi deal 108
Q4 cash burn estimate (45.0)
Q4-end cash balance 1,132
Dec 2013 share count (mm) 1,103
Cash per ordinary share 1.03
Cash per ADR share 3.08
Current ADR price per share 4.63
Market cap ~1,700
Facebook defines monthly active users as users who logged in during the month so this is the same as RENN’s monthly unique logins. Facebook had 1,228 million MAUs at the end of December 2013 and EV/MAU of roughly $140, while RENN’s EV/MAU is $11, and this is counting RENN’s Renren.com users only – 56.com or the game business is not counted. Facebook recently bought WhatsApp with 450 million monthly active users for $19 billion, paying 40 dollars per MAU.
When Alibaba made an investment in Weibo (China’s Twitter-like service), it valued Weibo at $3.3 bn. At that time Weibo had about 50 mm Daily Active Users. People who use Weibo tend to check it every day so we think the MAU, which is not disclosed, is not likely to be substantially higher than 40 mm. Weibo’s Value/DAU is $66.
How this investment could work out?
Better mobile monetization on Renren.com
A key concern surrounding Renren is its ability to monetize mobile users and its relevance on the smartphone. The strongest and fastest growing messaging app in China is WeChat by Tencent. WeChat is basically an instant messaging service and its counterpart is WhatsApp in the US and Line in rest of Asia. The main difference between WeChat and the messaging function of Renren’s mobile app is that Renren is real-name while WeChat is not. WeChat is mobile only (no PC version), very easy to use with communication features such as voice memos and sharing features such as Friend Circle (where users can post pictures and status updates). WeChat’s monthly active user base grew from 60 mm in Q1 2012 to 271 mm at the end of Q3 2013. Driven by this development, Tencent’s stock price doubled in the last 12 months.
At every RENN earnings call, analysts ask management how they are going to compete with WeChat. Jack Ma of Alibaba got very nervous about WeChat as well. In his 2013 annual letter to Alibaba employees which is widely publicized, he warned of the threat of WeChat. Alibaba even developed a WeChat copycat last year and Jack Ma demanded every Alibaba employee must sign up a certain number of users outside of Alibaba.
As mentioned above, users of Renren.com are spending 80% of their time on the Renren app instead of the desktop website, while only 10% of advertising revenue comes from mobile. Joseph Chen has outlined the following difficulties that the company has had with mobile monetization:
(1) 2.5G and 3G network is slow in China. When users click into a mini advertising site on their smartphones, the slow connection speed causes a drop in conversion rate.
(2) Small medium enterprises (SME) are more willing to try out mobile advertising than big brand customers because SMEs make decisions faster and just want to see results. However, Renren thinks SME advertisements are often not well designed and negatively affect the mobile user experience, and actually refuses their business at this time.
(3) Large brand customers (such as consumer goods companies) care about third-party measurement platforms to measure the effectiveness of ad campaigns. Such platforms are already established on the PC but on mobile there are no dominant third-party data providers. This has deterred brand customers to commit significant advertising budget to mobile.
(4) Overall, large advertisers are still slow in adopting mobile advertising. In Q2 management says "Our short-term goal is to create better management tools to show the effectiveness of mobile advertising while further educating this nascent market. This will be an important step in creating advertising roadmap for 2014 and beyond.”
We think the mobile monetization concern is priced in and from here many problems are fixable. 4G is being rolled out in China and Internet is moving to mobile – advertisers will eventually accept that they need to figure out how to do effective mobile advertising.
It is also worth pointing out that users are still spending a healthy 8 hours per month on Renren (up from 7.1 hours a year ago). 10% mobile advertising revenue is small, but a significant change from “immaterial” in Q4 2012. Management has also introduced a concept called “social messaging service” (SMS) in order to integrate the core messaging function on phones with the established Renren social platform. We are encouraged by the company’s recent revamping of the Renren app – it now does basically everything that WeChat does including voice memos and even includes a calling feature similar to Skype. Renren has also made messaging on the app much easier and accessible.
We think it is too soon to conclude that Renren.com has a bleak future implied by the stock price – it has access to a young and increasingly richer demographic and a strong presence in high schools and colleges where kids care about having a social presence and need to stalk their classmates. It also has access to real names and data on where people go to school and work (users fill out this information in their profiles). These data are not generally available in other parts of the Chinese Internet space that is large anonymous. We think if Renren can’t monetize these data, someone else will.
Better monetization of 56.com
The revenue discrepancy between 56.com and Youku (NYSE:YOKU), the leading video website in China is huge. The primary difference between 56.com and YOKU is that YOKU actually spends a lot of money buying programming while 56.com relies on cheap UGC. However, be careful not to think of 56.com has a site full of short cat videos. It actually hosts a variety of unique and interesting content.
Management recently commented that they had just started monetizing 56. We don’t expect 56 to generate $500 mm of revenue like YOKU, but we think the current $3 mm/quarter has an upside from here.
The biggest three Chinese Internet companies are Baidu, Alibaba and Tencent (“BAT”). Out of BAT, only Baidu does not have a dominant social networking business. Tencent operates its legacy social franchise QQ and the new WeChat. Alibaba made a $586 mm (18%) investment in China’s Twitter-like service Weibo owned by SINA last year and will likely invest more as SINA spins off Weibo. We would not be surprised that BIDU, LNKD (which recently hired former Nuomi executive Derek Shen to build out its China business) or another strategic buyer is interested in Renren.
In addition to the core assets, Renren also has the following major investments:
(1) 35% stake in Mapbar, a second-tier automobile navigation business competing with Internet giants like Baidu, AutoNavi (NASDAQ: AMAP) which was recently bought out by Alibaba, and Tencent. AutoNavi has about 30% market share, Baidu 24% and Tencent 2%. Mapbar’s market share is about 10% (#3 in the market). The Mapbar investment is booked at $24 mm on the 2012 annual report. Renren invested $26.6 mm in Mapbar in October 2011.
In the past year, Chinese Internet companies such as Baidu, Alibaba and Tencent have been pushing from online to offline (“O2O”), hoping to monetize their online traffic with commerce activities on the ground. To do this, there has been a flurry of M&A activities around this theme this year alone:
- Baidu’s purchase of Nuomi from Renren so that Baidu can direct its Internet traffic to buy discount goods and services
- Alibaba’s recent purchase of AMAP (also done in two steps – first a strategic investment then a full buyout) so that Alibaba can tap into user location data.
- Tencent’s strategic investment in Dianping, China’s Yelp-like service, likely valuing it at ~$2 bn (amount is not disclosed), valuing its 100 mm MAUs at $20 each.
We encourage you to read the press releases of these deals to get a sense of their rationales.
(2) 27% stake in SoFi, a Silicon Valley social finance start-up targeting the student loan market. SoFi connects alumni investors to lend money to students from their alma maters. 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 guys from KKR Financial and Sallie Mae. SoFi has been featured in many recent WSJ and CNBC stories and we encourage you to look it up if you are interested. Joe Chen’s rationale for the SoFi investment is that there could be synergy opportunities between a social network dominated by students and a social lending business. Based on our due diligence, we couldn’t get comfortable with the sustainability of SoFi’s business model. In the 2012 annual report, the SoFi investment is carried at $48 mm. Renren invested $49 mm in SoFi in 2012 and also bought $10 mm of SoFi’s securitized student loans yielding 4%.
(3) Japan Macro Opportunities Offshore Partners
Renren made an investment of $20 mm in this fund in the business of shorting Japan run by Kyle Bass.
(1) Renren a $6 mm investment in Gaoxue, a Chinese test-prep business similar to Kaplan.
(2) Renren operates Jingwei, a LinkedIn-like service. The RENN executive who internally started the Nuomi business was actually recently appointed to head LinkedIn’s new China market. Joseph Chen recently said he will continue investing in Jingwei, but we find it unlikely that Jingwei will be able to compete with LinkedIn. Renren.com also operates an internal career section targeting college students.
(3) RENN established a US subsidiary called Appsurdity in Silicon Valley in 2012. Appsurdity is run by Matthew Murphy who worked at Chegg and Etrade. Appsurdity has developed two apps – Quad (group messaging tool) and Dubbler (the equivalent of Instagram in the voice world). Based on our due diligence, these are well-liked apps (pretty high ratings) but don’t have the scale to support a valuation. Joseph Chen and Murphy toured a few US college campuses to promote the apps. You can download these apps to see for yourself.