China Internet IPOs: Approaching One Year After The Boom

by: Stone Fox Capital

At the end of 2010, China internet stocks saw a surge in interest leading to some rather magnificent IPO pops. The next Facebook, Amazon (NASDAQ:AMZN), Akamai (NASDAQ:AKAM), and many other leading tech companies were launched onto the US markets at sometimes very expensive prices. Investors were eager to obtain the next big thing from the fast growing China economy. Back in April I wrote about how investors should beware of the meteoric rise in the below four IPO stocks. [See China IPOs Gallop Out of the Gate: Time to Buy?]

Unfortunately as months have passed, the picture isn't so bright for the sector these days. The problem relates to the distrust in China stocks in general due to numerous fraud allegations that hit the reverse merger sector. Then some previously thought to be legitimate China stocks like Longtop Financial and Sino-Forest were accused of frauds causing even the IPO stocks to come under question. Combine that with high valuations and the stocks have plunged since the post IPO pop.

Has the business case really changed for these stocks? Not really, as most of the companies continue to hit revenue and earnings targets with most even guiding up. It appears to be an over-hyped situation where the momentum is now dead. Long term China internet companies like Baidu (NASDAQ:BIDU) and Sina (NASDAQ:SINA) remain strong stocks.

BIDU is the Google (NASDAQ:GOOG) of China and SINA is the Twitter of China. So the theme remains intact giving last year's internet companies the potential to regain that glamor. Maybe a few more strong financial reports will entice investors to return.

Most of the companies now trade at reasonable valuations, though growth rates haven't slowed. For example, Qihoo 360 Technology (NYSE:QIHU) trades at 35x the forward PE while the 5 year growth rate remains at 60%. In fact, earnings estimates continue to rise with 2012 jumping from $.44 to $.62 in the last 30 days. The company guided to 170% revenue growth for Q3. What is not to like about that? Unfortunately the stock peaked above $34 and now trades around $22.

Summary of the bigger IPOs in late 2010, early 2011:

ChinaCache (NASDAQ:CCIH) - Offer date 9/30/10. Leading provider of content and application deliver services in China. Revenue continues to grow at a 50%+ clip. One of the concerns is that CCIH has faced higher costs, which is pressuring margins. With the fast growth rate and exploding internet market in China, it is choosing growth over margins at the current point; similar to a (NYSE:CRM) model. Still, the company trades at less than 2x revenue and 15x earnings for 2012. Stock hit $35 back in November and is now below $7.

E-Commere China Dangdang (NYSE:DANG) - Offer date 12/7/10. Leading business-to-consumer e-commerce company in China. Revenue is growing at 50%+, but analysts expect losses for 2011 and 2012, at least. The company is facing tough margin pressure while building out fulfillment centers similar to issues that (AMZN) faces all the time. The stock peaked over $35 back in January and is now trading close to $7.

Qihoo 360 Technology (QIHU) - Offer date 3/29/11. Number three internet company in China based on its 378 million active users. Also the number one provider of internet and mobile security solutions. As mentioned above, the company continues to see massive growth with rising earnings estimates. With a forward PE of 35 the stock will soon become too cheap to ignore. A few more quarters of solid financials and the market will likely pile into this stock. (NYSE:YOKU) - Offer date 12/7/10. China's leading internet television company. Revenue is growing over 100%, but it reported an EBITDA loss. Analysts do expect a small profit next year, but that isn't much for a company trading at 10x revenue. The stock hit around $70 back in April and has dropped all the way to $21 now.

Even though these China internet companies have struggled after initial IPO pops, it hasn't stopped the parade of new companies. Leading online video site Toudou (NASDAQ:TUDO) recently IPO'd and just last week news leaked that has plans for a $4-5B IPO that would become that largest internet IPO in the US.

This increased supply is probably as big of a contributor to the demise of the sector as the fraud scandals. Combined they lead to less investors willing to take risks with more supply to soak up. Pay attention to Q3 results as the couple that show continued progress might just be worth adding to the portfolio.

Disclosure: I am long CCIH.

Additional disclosure: Please consult your financial advisor before making any investment decisions.