Facebook Could Learn From Renren's Margin Mistakes

Did Renren (NYS: RENN) just open a time capsule from the future of Facebook?

The China-based operator of online games and a large social networking portal just reported first-quarter results. At first glance, it's exactly the hyper-growth story you might expect: Sales jumped 56% year over year on 91% higher gaming revenue.

But mo' money really does lead to mo' problems sometimes. The rising sales were not enough to overcome exploding costs of operation, and last year's adjusted net loss of $1.1 million jumped to $11.3 million of red ink. Gross margins eroded from 80% to 61% and operating expenses doubled. The only saving grace on the income statement, once you move down from the hefty sales gains, was the $5.9 billion of interest generated by the funds from last year's IPO.

This could very well be a glimpse of Facebook's future. Renren's user base is growing fast and the ad clicks are rolling in, and yet the bottom line bleeds a deep crimson. CEO Joseph Chen pretty much cops to being late in the mobile game, promising to jump into the smartphone space as fast as possible.

Renren's mixed bag shows that the correlation between social media users and bottom-line profits is very loose. Margins can turn ugly in a hurry if ad partners start to back away, like they did from Renren this quarter. CFO Hui Huang blames the sputtering Chinese economy and the immature stage of his mobile monetization plans. One factor is obviously out of Renren's control (just as Facebook hardly can control the American economy), but the other could have been avoided by a visionary management team (and Facebook is singing the same mobile song).

Renren investors are eating the report up, boosting share prices as much as 13% in early trading. The stock has now gained 67% in 2012 but still dropped 65% from last year's opening-day highs. It's enough to give a sea captain motion sickness. Some of the best investments on the market are international high-growth plays, including the Fool's top stock for 2012 -- a Latin American retailer with a surprising pedigree. But I'd suggest staying away from Renren until it figures out those margin issues.

At the time this article was published Fool contributorAnders Bylundholds no position in any of the companies mentioned. Check outAnders' holdings and bio, or follow him onTwitterandGoogle+. The Motley Fool has adisclosure policy.We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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