Renren's Recent Earnings Losses Are Simply Growing Pains

| About: Renren Inc. (RENN)

Renren (NYSE:RENN) is hoping to overcome early setbacks and prove itself as a contender in the growing field of Chinese internet stocks. The social network, known colloquially as China's Facebook, has struggled to establish itself after its American IPO in 2011 and a subsequent collapse in stock price relating to a downward revision in the company's estimate of the size of its user base. Since its post-IPO struggles, Renren has effectively utilized invested capital, and is currently in the process of building up a diverse range of online services that it hopes will lead to eventual profitability.

As one would expect, this period of expansion has involved high levels of capital expenditure and, as a result, Renren has posted net losses on all recent earnings reports. The losses have, however, been consistently less than consensus expectations, and the latest earnings call on May 13th of this year was no exception. The company posted losses of only $0.01/share, which represented a year-over-year EPS growth of a paltry 2 cents, and a gross margin improved to 64.4% from 61.1% a year earlier. The report showed that the slow growth resulted from deteriorating top line growth in key sectors, namely advertising, and that recent developments in the Chinese streaming-content-provision market have left certain of Renren's recent acquisitions at risk of falling flat. The news was not all as weak as the broad overview would suggest, however, as business jumped in online gaming (51% increase in revenues) as well as other non-advertising ventures that represent more tangible growth opportunities (although these sectors tend to have potentially lower ceilings than advertising).

Belief in Renren has recently been bolstered by the performance of Nuomi, an e-commerce venture roughly based on the design of Groupon. This particular subsection of its business posted 102% YoY revenue growth ($5.1 quarterly earnings) and boasts a growing customer base. Nuomi has also begun to develop brand loyalty amongst its users; 54% of its customers in the last quarter were recurring. The increase in revenue growth for this particular service also signals Renren's ability to attract customers with greater purchasing power, which is important as one major concern in the early days of this company was that its user base was primarily students (as pointed out in this report from ChinaDaily), a fact that threatened to make monetizing the social network's web services difficult.

On the (somewhat) bright side, Renren is not alone in its current predicament. Many Chinese internet companies are feeling the pressure involved with adequately monetizing their services, but with a massive market into which it can expand and increasing penetration in mobile markets, these companies, including Renren, have a bright future. The markets seem to be in agreement with the fundamentals, as Renren's recent reversal was an emphatic one. The stock bottomed out in April and was shortly thereafter lifted on strikingly high volume into a v-shaped uptrend. The stock is trading in the $3.30-$3.40 range as of the time of writing, having clawed its way back from a low of $2.52, and remains nearly $0.70 off the New Year's highs.

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Chart courtesy of TD Ameritrade's ThinkOrSwim platform

Renren is unlikely to make any major moves in the immediate term, barring any shifts in market fundamentals. However, like most Chinese internet stocks, RENN's long-term potential ought not be ignored. The site boasts over 150 million users already, but considering the massive population of its domestic market, it should be noted that it has plenty of room into which to expand. The number of active Chinese internet users is set to expand to over 600 million in 2013, a number which would represent less than half of the population. [For the sake of comparison, around 245 million (≅78%) of Americans are active internet users.] The market (and, perhaps more importantly, the Central Committee) has come to fully embrace online gaming, and Renren's continuing investment in this sector is looking rather prescient. Online and mobile gaming revenues exceed those of advertising in China, and Renren has shown little hesitation in throwing its full weight behind the expansion of these and related services. Monetization of these operations will likely remain an issue in the near- to mid-term, but this issue is not unique to the company and margins will improve as R&D efforts reap results.

Renren's success in achieving a high penetration rate into the mobile market (something of a positive element of a younger user base) will ultimately be one of if not the most important element of its growth, as is true of any growth-oriented internet stock in the current market. In Q1 2013, mobile use made up 74% of total user time on Renren's main social network. The mobile sector will continue to post relatively weak earnings until Renren has developed a suite of apps and an advertising strategy that will adequately serve its needs and wants.

Though it is unclear as to when, Renren appears poised to solidify a prominent position amidst the competitive, but ultimately tolerant, field of Chinese online giants. Investor outlook on this and related stocks has been buffeted by uncertain macroeconomic conditions, but ultimately continues to trend upwards. The Chinese internet user base is growing rapidly with the spread of technology and rising consumer spending, and each new customer represents an opportunity for RENN to emulate its western counterparts and dominate the domestic social media and online gaming markets.

Disclosure: I am long RENN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long the Jan RENN 2.5 Calls