For more than two years, investors stayed away from Chinese Internet stocks, sending the shares of publicly traded companies lower. Baidu (BIDU), for instance, is down 30 percent, Sina (SINA) down 50 percent, and Renren (RENN) down 80 percent.
While part of the decline can be attributed to a sluggish performance of the Chinese market - iShares FTSE China (FXI) is down 18 percent over the same period - Chinese Internet companies had their own specific problems: lack of profitability, and some had problems with regulators both in China and the U.S. that frightened investors.
Baidu's recently announced IQiyi video website, and Alibaba-Sina's latest $586 million deal whereby Alibaba Group purchased an 18 percent stake in Sina's Weibo micro-blogging service - something like the Twitter of China - may be changing the game for Internet stocks, as it confirms that there is plenty of value in the sector. With 560 million Internet users spending 20 hours a week on line, China is by far the largest Internet market of the world, more than twice the size of the U.S. market. The trouble, however, is that the Internet market is a brutal market, where most companies have a hard time trying to monetize their business model. What should investors do?
Be selective. Buy companies with sound financials, like Baidu and Sohu (SOHU), in addition to Sina, but steer clear of companies with shaky financials like E-Commerce China Dangdang Inc. (DANG), Renren Inc., and Youku (YOKU). I particularly like Baidu, because it is an early mover that has amassed both economies of scale and economies of scope. The company's revenues have been growing by leaps and bounds; reaching $3.5B in 2012, up from $515 million in 2008 - coming from several sources: Internet search, where the company holds a 70 percent market share; video stream (iQiyi) - to be offered in an IPO; online travel services (Qunar); online recruitment (Baijob); and online payment systems (BaiduPai).
Simply put, Baidu is the Google (GOOG), the Netflix (NFLX), the LinkedIn (LNKD), the Priceline.com (PCLN), and the eBay (EBAY) of China; and is trading at favorable financials, compared with both its U.S. and Chinese peers - see tables below. Baidu, for instance, has a PE of 12.71 compared to a 16.63 for Google; and an operating margin of 46.52, well above those of its American and Chinese counterparts.
Financials of U.S. web companies
Financials of Chinese web companies in late April 2013:
Forward P/E (Dec. 2014
Internet search engine
Media and mobile value-added services
E-Commerce China Dangdang Inc.
Business -to-Consumer e-Commerce
Brand advertising, on-line gaming
A few words of caution: As is the case with other private companies in China, Baidu's business is at the whim of the government that can change the rules of the game at any time, turning winners into losers. Baidu's financials should be interpreted with caution, as Chinese accounting standards are different from those of the U.S. - so they aren't comparable with those of their U.S. counterparts.
Additional disclosure: Short on NFLX