May 24, 2024

DealBook: Finding Long-Term Value in Renren

Executives of Renren, one of China's largest social networks, at the New York Stock Exchange on the first day of trading of the company's shares.Adam Au/Reuters Executives of Renren, one of China’s largest social networks, at the New York Stock Exchange on the first day of trading of the company’s shares.

Many of Renren’s investors profited handsomely from the company’s initial public offering, when shares priced at $14 on Wednesday. But a venture capital firm, DCM, which owns 7.5 percent of the Chinese social networking site, is holding on to its stake.

On Wednesday, a DCM general partner, David Chao, talked to DealBook about the long-term value of Renren and why the firm is bullish on China. The company, which has an office in Beijing, has made 28 investments in the region since 1999 — nine of which have gone public.

Mr. Chao, who recently replaced Derek Palaschuk as the chairman of Renren’s audit committee, also discussed the recent questions surrounding the company’s financials. Mr. Palaschuk stepped down last week amid accusations of accounting fraud at Longtop Financial Technologies, where he has been a chief financial officer since 2006.

What is driving investor interest in Renren?

There’s the huge growth of the middle-income class in China. People used to say 10, 15 years ago, that maybe 10 percent of China’s population was middle class, that was about 150 million then. They say today that the number is closer to 400 million. We’re talking about a country where the middle class alone is larger than the entire population of the United States. These people buy cars, broadband services, smartphones. That’s really the engine behind the growth.

Companies that capture that momentum well will do very well. Now, five years, 10 years from now — when some of that growth slows down inevitably — I think you will see some of the valuations more akin to their U.S. counterparts.

Are you concerned that the valuations of Chinese Internet companies like Renren or Youku are too high?

When Youtube was purchased by Google for $1.6 billion, Youtube had significantly less traffic than what Youku has today. Did Google overpay, underpay? I think quite frankly, in the beginning people thought Google overpaid. But now people think it was a fair or low price.

If you accept the thesis that China is the world’s largest Internet market by number of users and that it will soon become the second-largest media market in the world, then the valuations for the market leaders in each segment of the Internet space – if they can maintain their position long term – are justified.

China’s social media space is pretty crowded. Are you worried about Renren’s position in the market?

Renren is about real identity, on par with Facebook. I think you have to look at the fact that Renren is the largest real identity Web site and it’s jumped into social commerce. And it has done it a lot earlier than Facebook. Nuomi [Renren’s group buying site] is one of the top Groupon sites in China.

Net net, we continue to believe that it is an exciting story. Whoever is No. 1 in this segment is probably going to continue to do well. If you look at the winners of each wave of the Internet, it’s pretty obvious that all the winners are multibillion-dollar companies.

What is your response to critics who say Renren’s financials are not very strong, that its per user monetization rates pale when compared with Facebook?

It looks like a wide gap. But if you look at the average of a Chinese person versus the average U.S. person, the gap is like 5x to 10x. I think people should not view things in absolute terms.

The company was also criticized for an accounting issue last month, when it revised the number of monthly unique logins for the first quarter.

First and foremost, the company refiled. At the end of the day we filed with the right numbers. It was a typo that was printed. China is still a developing country. If you look historically at accounting standards around the world, there are countries that have to catch up to others. Having said that, it’s really hard sometimes, when you’re in China and you’re in a business dinner and you bring this topic up. Chinese business people will say what about Enron, what about Tyco?

As a venture capitalist in China, where are valuations starting to feeling frothy?

We haven’t seen a tremendous increase in competition, because we largely focus on the early stage. When we back companies like Renren, they are still very small companies. On the early stage side, we’ve seen a little bit of a price creep, but not much compared to later stage investments which have to price relative to current public market valuations. The increase in prices in late-stage deals has a far greater impact on venture returns.

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