Diversification Should Sort Renren Out


Chinese social networking company Renren (NYS: RENN) seems to be sending out mixed signals as it posted first-quarter results, with losses greater than in the same period last year. On the other hand, however, its revenue surged beyond analyst estimates.

Quick look at the numbers
Renren's first-quarter revenue rose a substantial 56.1% from the year-ago quarter to $32.1 million, mainly driven by the company's Internet value added services, which clocked in an impressive 83.1% growth. The growth in Renren's IVAS segment was mainly prompted by online gaming revenue, which went up by a staggering 91%, as recently launched games became increasingly popular.

However, Renren's online advertising segment proved to be a point of concern, as it recorded a meager 15% growth from the prior-year period. While this can partly be attributed to seasonality, it was also the indirect result of the general economic slowdown that China has been experiencing for some time now.

What has not helped either is the fact that Renren's expenses have been skyrocketing lately. Operating costs went up by 90% along with an 82% surge in research-and-development-related expenses, as the company invested heavily on increasing bandwidth and creating newer online games. No wonder then that the company's bottom line stayed in the red as it reported a loss of $13.6 million.

Given that the company's expenses seem to be rising faster than its revenue, does Renren really stand a good chance in the long run?

The brownie points
Chinese Internet-based companies are no strangers to spiraling costs. Search engine specialist Baidu (NAS: BIDU) , whose first-quarter revenue grew by 8,275%, witnessed an astounding 75% rise in its operating expenses, out of which research and development consumed almost twice the cash it did last year. Others such as SINA (NAS: SINA) fared no better as operating costs shot up by 61%, as the company was seen investing heavily in its microblogging platform.

Nevertheless, while Renren certainly needs to rein in inflating costs, one should understand that this is happening primarily because it's still in expansionary mode. For a young company, I feel that these expenses are quite natural and are justified.

What should really work in favor of Renren is its balance sheet, which seems well-positioned with more than $1 billion in cash and equivalents and absolutely no debt whatsoever. That should give Renren some time to expand, capture market share, and slowly turn its loss-making business into a cash-rich one. And then there's the "diversification" factor...

Diversity is strength
Renren might be called the Facebook of China, but it isn't just a social networking company. Its business is diversified. Apart from having a profitable online gaming division, Renren has acquired 56.com, a Chinese video sharing website similar to YouTube. The company even has its own e-commerce site known as Nuomi.com, which is somewhat similar to Groupon, but could be even better than that as Renren has a steady user base, thanks to its social networking predominance.

The Foolish bottom line
While the weak online advertising market in China might be a dampener for Renren for some time to come, as is evident from the company predicting lower-than-expected second-quarter revenue, its diversified operations should see it through the present tough times. With online advertising revenue in China estimated to increase more than two-fold to $9.5 billion in 2014 from $4.6 billion in 2011, I feel that Renren is poised to grow and turn profitable in the long run.

What do you think of Renren's future? Let us know by leaving your comments in the box below.

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At the time thisarticle was published Keki Fatakia does not hold shares in any of the companies mentioned in this article. The Motley Fool owns shares of Baidu. Motley Fool newsletter services have recommended buying shares of SINA and Baidu. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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