Four Crimson Flags for Weibo’s Future

Weibo (NASDAQ: WB), a Chinese social media company often compared to Twitter (NYSE: TWTR), may seem like an undervalued growth stock. Its microblogging platform served 573 million monthly active users (MAUs) in the most recent quarter, up 12% year over year, while revenue for the first nine months of 2021 grew 39% year over year.

Analysts expect Weibo’s full year sales and earnings to rise 33% and 29%, respectively. It faces simple comparisons to its slower growth during last year’s pandemic, but its stock looks cheap, with only nine times future earnings and about three times sales next year. Unfortunately, four red flags indicate that the stock could be a value trap.

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1. Sina’s privatization

Sina, one of the oldest internet companies in China, spun off Weibo in an IPO in 2014. However, Sina continued to retain a controlling stake in Weibo and relied on the social network for a large portion of its revenue.

In early 2021, Sina privatized and delisted its shares from NASDAQ. The $ 2.6 billion deal – in which Sina was handed over to New Wave, a holding company owned by Sina’s CEO – was arguably undervalued on Weibo and appeared to have no value whatsoever to Sina’s other companies.

At the time of the privatization, Sina still owned 44.9% of the shares in Weibo, which gave her 71% of the voting rights in the company. Weibo had a market cap of nearly $ 12 billion on the day Sina delisted its shares, meaning a 44.9% stake in the company was worth well over $ 2.6 billion.

Sina’s investors couldn’t block the lowball deal as New Wave also held a majority stake in Sina. This delisting burned many US investors who viewed Sina as an arbitrage game on Weibo. It also sparked rumors that Weibo could go private at a steep discount, and revealed how little control Weibo foreign investors actually exercised over Sina.

2. Weibo’s disappointing Hong Kong IPO

Weibo denied these privatization rumors in July, and its Hong Kong IPO in December indicated that it would like to remain publicly traded.

Unfortunately, Weibo’s Hong Kong IPO didn’t impress many investors. The stock was trading at Hong Kong $ 272.80 ($ 34.98), but the stock closed at HKD 253.20 ($ 32.47) on the first day of trading and is now worth about HKD 225 ($ 28.85) . That flooded IPO shows that Chinese investors aren’t overly optimistic about Weibo’s future either.

3. Alibaba’s big sale

Alibaba (NYSE: BABA) bought an 18% stake in Weibo immediately after going public in 2014. That stake had risen to 29.6% by September 2021, making Alibaba the company’s second largest shareholder after Sina.

Alibaba’s stake in Weibo sparked speculation for years that the e-commerce and cloud giant might take over the social media company. However, according to recent reports, Alibaba could sell that stake to state-backed media company Shanghai Media Group.

Alibaba may consider this divestment to reassure antitrust authorities and reduce government control over its media-related investments. Tencent also recently made a comparable concession by selling its stake in the e-commerce giant

Alibaba’s potential sale raises red flags for Weibo for two reasons: A sale to a government-sponsored media company could introduce even stricter censorship restrictions on the social network and limit the future integration of Weibo into Alibaba’s platforms.

In the past, Weibo has referred its users to Alibaba’s online marketplaces and used AliPay (by Alibaba’s subsidiary Ant Group) to power its Weibo payments platform. Removing these features could harm both companies.

4. The regulatory headwind

After all, Weibo is not immune to China’s crackdown on its top tech companies. The public relations director was arrested in August on charges of bribery, and the Cyberspace Administration of China (CAC) recently fined Weibo three million yuan ($ 471,031) for vague allegations of inappropriate content.

That’s a slap on the wrist for a company forecast to generate $ 2.25 billion in revenue this year, but it suggests the government will continue to strictly monitor and censor Weibo’s content. That review could intensify significantly if Alibaba sells its stake to Shanghai Media Group.

In the past, Weibo has spent a lot of money developing AI algorithms and hiring censorship teams to monitor its content in real time. If the Chinese government wants Weibo to apply even stricter censorship standards, operating costs could skyrocket and profit growth slowed.

Even as Weibo overcomes its regulatory challenges in China, it still faces looming delisting threats in the US, where securities regulators have tightened their auditing requirements for overseas companies.

Weibo’s stock is cheap for obvious reasons

Weibo may seem like a compelling alternative to Twitter and other American social media companies at first. However, Weibo stock is cheap because it faces way too many challenges in the near future. Investors should wait for these headwinds to subside before re-evaluating Weibo as a value game.

This article represents the opinion of the author who may disagree with the “official” referral position of a premium advisory service from the Motley Fool. We are colorful! Questioning an investment thesis – even one of our own – helps us all reflect critically about investing and make decisions that will help us get smarter, happier, and richer.

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