Sina Corp.: Acquisition Rumors Have Led to Inflated Prices -- SELL

David Riedel of Riedel Research Group recently published a note for clients regarding Linktone's (LTON) tough outlook. Excerpts follow:

According to a survey of China Online Advertising Market Tracker 2006 by Analysys International, Sina Corp. (SINA) maintained No. 1 in online ad revenue market share in 1H2006. The Company accounted for 20.7% of total market size.

SINA as a news portal has only one powerful competitor, Sohu.com Inc. (SOHU), while Baidu.com Inc. (BIDU) is a search engine.

In 2Q2006, the Company’s ad revenue hit record high of $29.5M, rising by 32.8% Q-O-Q and 44.6% Y-O-Y. It may be argued the 2Q result benefited from 2006 FIFA World Cup, so that growth will not continue. But we believe SINA’s ad revenue growth is sustainable for three reasons:

• The online ad market size of RMB2,095M in 1H2006 is 64.9% of whole year 2005, which suggests a strong growth for the market size.
• On July 11, Union of Network Beijing announced a blacklist of top 10 malicious softwares, on which are three of top 10 online ad market share holders, Baidu, Yahoo China, and Zhongsou. We believe the blacklist will impact SINA’s competitors.
• There is a cycle for SINA quarterly ad revenue in last two year — weak in 1Q and growing in 2Q and 3Q, and the general trend is upward.

SINA net profit in 2Q2006 increased $3.4M by 48.4% Q-O-Q, but the net profit includes a gain of $2.0M from sale of interests in NC Soft, a Korean online game company. Operating profit grew by 15.2% Q-O-Q, close to revenue growth rate 14.9%; in other words, operating margin in 2Q maintain the same level as 1Q.

However, there is something positive when breaking up operating margin: Ad gross margin rose to 65.0% in 2Q from 62.6% in 1Q, and Mobile related business gross margin also rose by 1.6 percentage points, which is scarce among service providers. So general gross profit margin improved from 61.4% in 1Q to 63.4% in 2Q. (Ibid.)

Operating margin maintenance is due to rapid growth in general and admin expense, which increased by 44.0% Q-O-Q, compared to total revenue growth rate 14.9% Q-O-Q. SINA owes the expense rise to headcount and salary increases. It is a positive signal to recruit more employees, while other service providers are suffering a tidal wave of layoff. SINA’s advantage for surviving service providers’ hard time is the No.1 position in online ad market, and the Company’s online ad revenue obviously exceeded mobile related revenue in 2Q2006.

Valuation and Recommendation
We assume ad revenue will grow by 11% Q-O-Q and 7% Q-O-Q in 3Q and 4Q, while mobile related revenue will decline by 15% Q-O-Q in 3Q and 4Q. Our estimated ad revenue in 3Q is slightly higher than the datum in the Company’s outlook, while estimated mobile related revenue in 3Q is slightly lower than the datum in the outlook. We calculated a target price of $21.37, which is 15.8% lower than the current market price.

Acquisition rumors became hot again, and SINA’s market price has increased more than 15% since middle August. We believe a 15% acquisition premium is sufficient. SINA has advantages comparing to its peers, such as No. 1 in online ad market and more revenue from online ad than from mobile services. But we believe SINA’s trailing P/E 36.9x is significantly higher than historical data and P/E of Sohu.com Inc. (SOHU), SINA’s main competitor. We downgrade SINA to a SELL.

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