History does not repeat, but it often rhymes. In the 1990s, I covered what became known as the “Internet Bubble.” Huge valuations were attached to new companies that had no grounding in financial reality.
The internet itself has proven worthy of the hype, but most of the hot stock tips of the era were not. Still, there were some outliers: If you bought Amazon.com, Inc. (NASDAQ:AMZN) at the height of the boom, when Jeff Bezos was Time “Person of the Year” and the stock was priced over $100 after three stock splits, you’re still way ahead, even if you had to wait nearly a decade to break even.
Others — CMGI, Excite, AltaVista, Andover.Net, Pets.com — sank without a trace when the bubble popped starting in early 2000, and investors started applying conventional valuation techniques to the sector.
The internet may be even more transformative for China, changing it from a poor industrial society to a post-industrial consumer society. But America’s experience holds lessons for looking at today’s China Internet bubble.
Not everyone is going to win in the end.
Of the 30 largest Chinese ADRs traded on American exchanges in 2015, over half were technology outfits, most of them internet companies. Many will not be around in 2020. Those that are not unquestioned leaders in their field will likely fall by the wayside.
I may be wrong on some of the companies I think of as future losers in this market, but in general, I am deeply suspicious of companies that rely entirely on advertising, especially ad models from the past. I want to see business models that can be explained in just a few words, clear market leadership, and a niche that can be expanded easily over time without changing the corporate culture. And if you’re going to win in a huge online market, you need to get to a huge valuation.
Few U.S. internet companies in the 1990s had all that and some, like Yahoo! Inc. (NASDAQ:YHOO), proved vulnerable to firms with a tighter focus like Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL). But most of the companies my newsletter from that period, a-clue.com, called “clueless” were, while those I considered “clued-in” survived intact.
One other point. When you buy into any market outside the U.S., you are making a currency trade as well as a stock trade. In this case, you’re buying the Chinese Yuan and selling the U.S. Dollar. Over the last year, the Yuan has fallen from 6.55 to the dollar to 6.93. That’s a move of almost 6%. Chinese stocks would have to rise at least that much over the last year to break even for you. It’s something you need to consider.
If someone approaches you with any of the following stocks, my experience says you should be cautious, hold your dollars, and let your friend keep their Yuan. Yes, they’re up this week, but it could be a bursting Internet bubble could drive them all down hard. With that as a backdrop, here are five Chinese stocks to sell.
Chinese Stocks to Sell: Momo Inc (ADR) (MOMO)
Recent results disagree with me. The company earned $39 million, 10 cents per share fully diluted, on revenues of $157 million during its September quarter. Revenue was nearly 500% ahead of the $37.48 million achieved a year earlier, and profits were more than double the $15.71 million of the June quarter.
Analysts were pounding the table for the stock before its most recent earnings announcement and this continued afterward, with an average price target of $29, 44% ahead of the $21 per share the company was trading for at the time. Its high for the year — $27 — was achieved in October and at its current price of $22, it would seem to be a bargain.
So what is wrong with MOMO?
Nothing, says InvestorPlace contributor Chris Tyler. The negative momentum may all be over Donald Trump’s bluster concerning China, and that may just be bluster.
But Tyler also calls MOMO the “Chinese Tinder,” and I think it could burst into flames. An effort to take the company private in April, at a price of about $16.05 per share, failed and it’s likely the present price is too rich for its potential acquirers.
Consider that MOMO is presently trading at a price-to-earnings multiple of 68, and its valuation of $5.01 billion indicates a P/E multiple of over 10, even assuming the December quarter continues September’s growth rate.
There’s also MOMO’s reliance on “Wang Hong ,” or internet-created celebrities, for its growth. The U.S. has a lot of experience with internet celebrities, and those with staying power gravitate quickly to other media. They are judged alongside other celebrities.
It’s a fly-by-night business, and only those that fly fast to the mainstream have staying power. Neither the celebrities themselves, nor the business model of internet celebrity, has proven to be something you can invest in. You can speculate it, you can trade it, but you had better pay close attention to it because it’s going to crash. Most of the Chinese celebrities are selling their goods on other sites — it is only the fame that MOMO captures. That’s not enough.
MOMO, in short, is relying for its future on a youth culture that is going to grow up. China’s explosion of youthful energy is due to be short-lived, owing to the one-child policy and a consumer culture that has many of those kids avoiding procreation entirely. As China falls off the demographic cliff, in short, I expect MOMO to fall with it, unless it can quickly find another purpose.
The difficulty of finding another purpose is the problem with technology companies. Most have only one act in them, one purpose, and losing the niche means it’s time to sell. The buyers who passed on MOMO when it got over $16, in other words, are very likely to be making the right call, and can probably get it for much less when its present momentum fades.
Chinese Stocks to Sell: YY Inc (ADR) (YY)
In technology, there is a rule that the market leader gets 90% of the niche’s profits, the second-place company gets 9% and everyone else scraps for 1%. Another version of this saying is that if you’re not the lead sled dog, the view never changes.
Think of YY Inc (ADR) (NASDAQ:YY) as the Livestream of the Chinese internet. Then remember Facebook Live from Facebook.
The problem with being a niche player in something like social networking, even if you think that you have a secure niche, is that the bigger fish can still gobble you up, or take you down. Livestream is such a popular streaming platform that the word has almost become generic — we’re going to Livestream that.
But, again, there is Facebook Live. As markets mature, and the social networking market is maturing, the smaller niches within the larger niche become vulnerable to the bigger player. We saw this in PCs as Microsoft Corporation (NASDAQ:MSFT) won the office market from Lotus, even after that company was acquired by International Business Machines Inc. (NYSE:IBM). We saw it in database applications as Oracle Corporation (NYSE:ORCL) acquired the companies producing its vertical market applications in the last decade.
The same thing is true in China. The winner in this case is Weibo Corp (ADR) (NASDAQ:WB). It’s not YY.com. This makes YY a vulnerable Chinese stock.
Not everyone agrees. Deutsche Bank analysts are advocating a pair trade between YY and MOMO, selling the latter while buying the former. They see YY as having possible upside in areas like online dating and call the site stickier.
Most professional traders looking at the stock, however, prefer sell options to buy ones. They’re betting this Chinese stock will fall.
Right now, as noted earlier, the Chinese Yuan represents a downdraft for any U.S. investor buying Chinese assets. The Yuan has been falling steadily for months and now it trades at nearly 7 to the dollar, after being below 6.5 as recently as April. So YY’s stated third-quarter revenues of 2.090 billion Yuan translate to just $300 million.
The company has been taking nearly 20% of that revenue to the net income line. The country took on considerable debt in 2014 to build out its network, and while that debt has been declining, over 25% of the assets are still encumbered.
Like MOMO, YY.Com (the site is known as YY Live in China) is heavily reliant on internet celebrity, a fleeting phenomenon that, as mentioned in the section on MOMO, requires big media support to have a shelf life.
There are YY bulls who see the stock going as high as $67 per share in the coming year, but I just don’t happen to be among them. My guess is that either YY management will wisely take a buy-out offer from a larger player or the site will run into a growth wall, at which point the $2.3 billion market cap could disappear entirely.
It’s this risk of failure which has the stock priced at a P/E multiple of 13.4, and I think that when you’re investing in a foreign market, as opposed to trading momentum, it’s a risk you don’t want to take.
Chinese Stocks to Sell: 58.com Inc (ADR) (WUBA)
You can think of 58.com Inc (NYSE:WUBA) as the Craigslist of China. It is mostly a collection of classified ad lists, although its 58 Daojia unit does operate a closed-loop transaction platform for home services.
The word for 58, when spoken, sounds like the phrase “sure to prosper” in Mandarin, which is how the site took its name, although in Cantonese it means “not prosperous.” This is still propitious for the site, which aims to serve less prosperous people.
The word may already be out on 58.com, which has been downgraded recently by some analysts after falling by 58% over the last year.
The September quarter is thought by analysts to have been a disaster for the company. WUBA lost $29.82 million on revenue of $306.45 million, after scoring a profit on revenue of $297.82 million a year earlier. Still, the bulls reply, the debt is all short-term, and is less than the cash on hand and short-term investments. The average analyst rating is an outperform, but almost half the analysts who called it a buy three months ago have since swung to a more negative view.
While 58.com has a market cap of $4.53 billion, it is still subject to wild swings based on very little, like a recent Motley Fool analysis noting how a softening real estate market was kicking the legs out from under its growth engine. Despite its fall during 2016, this is still an expensive Chinese stock, with trailing-year revenue of less than $1 billion supporting that $4.53 billion market cap and no earnings.
Given the opacity of the Chinese marketplace for the American investor, it can be difficult to make any reliable call on a Chinese stock, but given the vulnerability of the whole internet stock market there to a sudden shift in investor opinion, I just find it hard to see this company as a long-term winner. Most likely, it will be sold after the downturn, leaving shareholders with less value than they have now.
Chinese Stocks to Sell: Sohu.com Inc (ADR) (SOHU)
Of all the U.S. Internet companies, the best comparison I can make for Sohu.com Inc (ADR) (NASDAQ:SOHU) is to Yahoo.
Don’t run away yet.
Like Yahoo, Sohu has a variety of content sites, but also like Yahoo it is primarily in the business of selling ads, not only on its own sites but on others as well.
There are other valid comparisons with Yahoo as well. For one thing, it’s not making money. Revenue is down at least 10% from the December quarter for each subsequent quarter, but expenses did not fall in proportion. As a result, the company lost almost $160 million, about $4 per share, for that period, which is significant when your market cap is just $1.52 billion.
The price of Sohu stock peaked in 2011 at over $100 per share. It got up over $80 twice more, in 2013 and again in 2014. Its high for the last 12 months is about $55. Revenue peaked in fiscal 2015 at $1.937 billion.
Yet there are people who like the stock. Institutions bought over $75 million of it during the third quarter of 2015, led by Schroder Investment Management, which had a stake of over 187,000 shares at the end of the period. The consensus rating on the stock is still a hold and one Seeking Alpha writer was calling it undervalued as recently as August.
The problem isn’t the search engine, which is still No. 3 in a market that has yet to fully consolidate. It’s mostly in the gaming business, which was partly spun-out and thus has its own ADR, Changyou.Com Ltd (ADR) (NASDAQ:CYOU). Changyou sold its 7Road business in 2015 and has yet to recover, although the unit is profitable.
I have several problems with this stock. First, it is considered an online pioneer in its market, so it should be much bigger by now. Second, its search engine is not the market leader. Third, CEO Charles Zhang remains entrenched after 20 years on the job. He is highly educated — MIT and Tsinghua University — but he’s 50 and no longer in touch with the youth market all such companies depend upon for growth.
There is always the possibility that another, more-successful Chinese internet company, or a U.S. company seeking a foothold in the Chinese market, could walk up with a $2 billion check and hand Sohu shareholders a profit. But all I’ve witnessed in 40 years covering this business is that such checks are seldom offered, and founders almost never take them.
So, yeah, the Chinese Yahoo. And, no, this one didn’t buy Alibaba Group Holding Ltd (NYSE:BABA).
OK, now run away.
Chinese Stocks to Sell: Sina Corp (SINA)
Especially since the stock went to over $84 per share as recently as October, nearly hit $80 again in November, and is now sitting near $67?
The best explanation I can give is EMC Corp.
Remember EMC? EMC, now part of Dell, makes disk subsystems for data centers. It is still big in the cloud, and it also owned 80% of VMware, which was also part of the Dell buy-out. The point is that back when both companies were publicly traded, VMware was by far the better investment.
The same is true here. It’s true that over the last year SINA is up 42%, but WB is up 156%, and as noted, SINA’s stake in WB has been cut. It could be cut further, whenever SINA decides it needs the money.
SINA itself grew about 20% year-over-year, between September of 2015 and September of 2016. It has assets of over $4.8 billion, and it has less than $800 million in debt against those assets. Of the 17 analysts currently following the stock, 10 have it rated as a buy, and the mean estimate for 2017 earnings is $2.20 per share. The market cap is up to $4.65 billion.
So why am I telling you to avoid this stock? It’s because Elvis, in the person of 35-year old Weibo CEO Gaofei Wang, has left the building. Wang has been head of Weibo since it started. Weibo is a better investment, and you can buy Weibo on the U.S. market, so what do you want with SINA?
SINA has had two straight strong quarters, mainly due to Weibo’s success in getting social users switched to its mobile platform (sound familiar?). You must wait until March to see if that success is sustained. But even if it is, you can buy that success directly. You don’t have to be tied to the old SINA “portal” to get it.
It is possible that I’m missing something here, and that SINA has some hidden gem I don’t know about. This is what makes investment in international markets so dicey, and why I am loathe to recommend any overseas stock with a market cap under $10 billion. But while most analysts still have this rated as a buy or an outperform, the good folks at Goldman Sachs took the stock down to a “neutral” rating at the end of November, with a price target of $50 per share, against the current price of $68.
That kind of move attracts my “spidey sense;” my instinct is that future change will be negative. Goldman doesn’t make these kinds of calls for no reason. It’s not a big move, but it’s enough when, as I say, there is a better play available.
Dana Blankenhorn is a financial and technology journalist. He is the author of the sci-fi novella Into the Cloud, available at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing, he owned no shares in companies covered in this story.