After having reported earnings yesterday, something jumps out. Renren (RENN) has turned into a clear sell. If we recall, the long thesis on Renren requires it to have a chance of becoming the Chinese Facebook. Its earnings, however, seem to show that the only thing Renren will probably emulate, is Facebook's share plunge.
Superficially, the earnings report didn't seem too ugly, with Renren beating revenue expectations and revenues growing 47.5% year-on-year. However, this is one of those cases where the devil is in the details. And oddly enough, the devil here comes disguised in strong growth. You see, Renren's online gaming revenues jumped 122.1% year-on-year and now make up slightly above 50% of Renren's entire revenue base.
And therein lies the problem. Renren is turning into an online gaming company and this is likely to continue, with online gaming turning into a larger and larger part of RENN, since online gaming is now responsible for all of RENN's growth! What's wrong with that? Well, there are many quoted Chinese gaming companies. And the problem is that they're wildly cheaper than Renren and quite a bit larger.
Companies such as Perfect World (PWRD), a $490 million market capitalization with a TTM P/E of 3.5. Or Shanda Games (GAME), a $960 million market capitalization with a 2012 forward P/E of 4.6. Or even Changyou.com (CYOU), which I bought recently, a $1.27 billion market capitalization carrying a 2012 forward P/E of 5.1 even after jumping 30-40% like it did.
These are large companies, too, with yearly TTM revenues of $468 million for PWRD, $850 million for GAME and $516 million for CYOU. RENN sits at $145 million or so after this quarter. RENN is simply not in the same league, yet RENN still commands a $1.6 billion market capitalization, larger than any of the companies mentioned, while still expecting negative earnings for the year.
In short, all of Renren's growth comes from online gaming, more than half of Renren's revenues already come from online gaming, every Chinese gaming company out there is profitable whereas Renren is unprofitable, every Chinese gaming company out there is much larger than Renren and all are wildly less expensive. As the market realizes this, it will end up selling Renren and buying other Chinese online gaming companies (if it wants to own Chinese gaming companies, that is).
Although business outside of online gaming is no longer growing, the number of users reported by RENN still remains on a growth path, so conceivably the rest of RENN might not be dead yet, and hope remains that the alternative thesis -- that it might turn into the Chinese Facebook -- is still alive. I highly doubt it, though, and when >50% of its revenues are from online gaming and are the only part growing, the thesis that it's just an online gaming stock is much more likely to get the market's eye.
Also, RENN does have a significant cash hoard, but that too is slowly vanishing, in part because of it repurchasing shares - yet the share count continues increasing year-over-year.
Renren's transformation into an online gaming company, implicit in its earnings report, means we have to compare it with other Chinese gaming companies. All are significantly cheaper, so much cheaper that in all likelihood Renren will see significant additional downward pressure.
Renren's main advantage is a large user base to which it can market its own games. Such is its best chance to stabilize the negative trend. However, such also seems too little to warrant paying a huge premium for it right now.
Disclosure: I am long CYOU.
Additional disclosure: I might also purchase GAME, PWRD over the next 72 hours.