These Market Trends Support Our Renren $3.20 Valuation

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Quick Take

  • Renren’s primary revenue sources are its advertising and gaming business. Ad spending on social networks in China is expected to double between 2012 and 2014, which provides the advertising business a big opportunity.
  • The growing number of mobile devices will enable users to continue playing Renren’s massively multiplayer online role-playing game on their mobile phones, which could build loyalty and spur in-game purchases.
  • Group buying is gaining popularity in China with the number of users growing at about 40%. Renren’s huge investments in Nuomi could return big gains if the company plays its cards well.

We recently launched coverage on Renren Inc. with a near $3.20 price estimate for the company’s shares. The company operates a Facebook-like social network in China called renren.com with an active user base of 178 million. Renren generates a majority of its revenues through advertising on its websites, online games and its group buying service, Nuomi. The advertising and online games businesses are particularly heavily dependent upon the social network.

Renren has had large operating losses for the past two years, primarily due to its group buying business, Nuomi. The losses can partly be attributed to the highly fragmented nature of the Chinese internet market where some firms have failed to reach the critical mass to survive in the long term. For example, the group buying market was estimated to have about 5,000 players in 2011, but fell to about 3,000 in 2012. [1] [2]

However, the ongoing consolidation provides support to an expected turnaround of businesses as the remaining group buying services will likely offer larger number of deals, which should help them reach the critical mass to generate profits. We expect Nuomi to emerge as one of the leader after this industry consolidation due to its large cash balance, which gives it the ability to acquire smaller players. Renren has already invested significant capital into Nuomi.

In this article we take a look at factors which support our valuation for the company.

See our full analysis for Renren’s stock here

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Social Ad Spend To Double By 2014

Research firm, eMarketer, estimates that the ad spending on social networks in China will double between 2012 and 2014. About 5.5% of total digital ad spend is on social networks currently and is expected to grow to 6.5% by 2014. [3] With China expected to become the second largest digital ad market in the world by 2014, this translates into a significant growth opportunity for Renren. [4]

Renren’s primary competition for advertising revenues will be the Chinese microblogs that are broadcast mediums which enable you to share thoughts within a limited number of characters. For example, Twitter in the U.S is an example of a microblog. Sina’s Weibo and Tencent’s Weibo are the two main microblogs in China. Renren’s social network, which is similar to Facebook, permits users to personalize his or her profile, share photos, videos, create and follow pages, and maintain a network of friends.

Microblogs and social networking sites are competing for attention in China with the microblogs currently having the upper hand. Sina’s Weibo and Tencent’s Weibo have approximately 400 million and 540 million users respectively, which are significantly larger than Renren’s user base of 178 million. [5] [6] We believe that the difference stems from the popularity of the services among various age groups. Renren’s social network is popular among college students or those fresh out of college. The microblogging sites enjoy a wider audience as they are popular with the older generation as well.

U.N. population data for China suggests that the population in college-going age will see an erratic trend over the next decade. [7] Hence, Renren will have to promote its utility to a wider age group to stay relevant. Despite the tough competition Renren faces ahead, we expect it to capture a larger share of the increased ad spending in China over the coming years because the company can track a user’s preferences on a more personal level than a micro-blog. This is expected to attract advertisers as advanced tracking could enable more accurate targeting of ads, and hence a better return on advertising dollars spent. As a result, we expect advertisers to spend more on Renren’s social network over the forecast period.

Popularity of Mobile Devices Supports Growth of Online Gaming

Massively multiplayer online role playing game (MMORPG), is a genre of role playing video games in which a very large number of players interact with one another within a virtual game world. As in all role playing games, players assume the role of a character and take control over many of that character’s actions. MMORPGs are different from single-player or small multiplayer online RPGs by the number of players, and by the game’s persistent world (usually hosted by the game’s publisher), which continues to exist and evolve while the player is offline and away from the game. The continuous evolution of the game prompts players to spend more time within the game, strengthening their abilities, unlocking new weapons and accessories through in-game purchases. Renren enables in-game purchases through its virtual currency, Xiaoneidou which can be bought in exchange of actual Chinese Yuan.

Renren is credited for launching popular games like “Last Battle of the Three Kingdoms” that won the Golden Page awards for ‘Most Anticipated Game of 2012’. The popularity of Renren’s MMORPGs stems from the ability to continue playing a game on other devices from where a user had left it before. The trend has become prominent with the growing popularity of mobile devices in China. There are 1 billion mobile users in China currently and the number is expected to keep growing. [8]

We expect Renren to further build upon the popularity of its games and leverage the ability to game across platforms. The popularity of the current games which are in the middle of their life cycles and the company’s plan to launch more games support our forecast for the gaming segment.

Popularity of Group Buying Supports Nuomi’s Growth

China Internet Network Information Center estimates that there are approximately 242 million users who currently shop online, a growth of 43% on 2011. [9] The growth rate in 2012 was substantially more than that in 2011 and points to the growing popularity of the Internet as a shopping destination. Of these 242 million users, approximately 83 million are users of group buying services. Group buying sites work by offering special discounted deals on a product or service from a featured company. If enough users buy into the discount, then the special deal is given to all those who participated. The most popular example of such service is Groupon.

The growing popularity of online shopping is accompanied by increasing adoption of mobile devices for group buying services. The number of users of such group buying applications increased by more than 80% in 2012, and with the number of mobile phones being sold in China expected to rise, we expect Nuomi’s registered user base to grow during the period. Also, Renren’s substantial cash reserves and Nuomi’s introduction into more cities are expected to increase the number of deals available on the service, as businesses and users from more cities sign up for the service. We expect more deals to increase the frequency of usage of the service, which will translate into a higher percentage of paying users.

To summarize, Renren faces strong competition for its primary revenue generating services in China. However, we expect that the company’s focus on research and development over the past couple of years will bear fruit in 2013, and support its strong growth rates in the near term. We have a $3.20 Trefis price estimate for Renren’s stock, which is 1% above the current market price.

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Notes:
  1. Group-Buying Sees Revival on Mobile Devices, Alipay Says, Caixin Online, January 2013 []
  2. Number of Group Buying Sites In October Down 42.5% from Peak, China Scope Financial, November 2012 []
  3. China Social Network Ad Spending 2010-2014, China Internet Watch, January 2013 []
  4. China to Become the Second Largest Digital Ad Market in 2014, China Internet Watch, October 2012 []
  5. Tencent Microblog Registered User Base Hits 540 Mln, MarBridge Consulting, January 2013 []
  6. Sina Reveals Q3 Financials, Announces Weibo has Passed 400 Million Registered Users, Tech in Asia, November 2012 []
  7. Population by age, sex and urban/rural residence, U.N. Data, February 2013 []
  8. China Rules The Mobile World With 1 Billion Users, CNET, May 2012 []
  9. CNNIC Released the 31st Statistical Report on Internet Development, CNNIC, January 2013 []