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This Chinese Internet Company Is the Best Investment of the Pack

May 29, 2014 | About:
Vinay Singh

Vinay Singh

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The Internet Services space was one of the top performing sectors of 2013, increasing more than 75%. In many ways, the performance is reminiscent of the dot-com era; the only difference is that Internet companies today have actual growth — not just speculation. With that said, certain Internet stocks have played a larger role in driving this industry higher, but do these stocks have more upside in store?

Online Real Estate

I remember clearly picking up booklets in my local grocery store to find houses for sale, but those days have come and gone, thanks in part to Zillow (Z). This is a company that offers a comprehensive list of new homes, rental properties, etc., along with pricing and history of those listings.

Zillow makes its money through advertising but also from realtors who pay to market on the company’s site. In 2013, the stock has returned an industry-leading 240% gain, as the company’s revenue continues to scale new heights.

In the most recent quarter, Zillow grew its top-line 69%; investors have apparently ignored the company’s four consecutive quarters of margin declines in favor of this growth. Currently, the company trades at 20.4 times sales and has a market cap of $3.3 billion. However, with just $150 million in revenue, there is no reason to believe that future fundamentals will ever support a $3.3 billion valuation.

Looking ahead, investors must worry about the company's margins. For example, sales/marketing rose 172% and R&D increased 91% year over year in the last quarter alone. With that said, when will growth outpace spending? At this point, there is no answer, which doesn't bode well for the company's future.

Diversity In A Large Market

YY (YY) is a Chinese social media company with a diverse range of product offerings that return revenue, including music, games and paid memberships. Due to this variety, some investors believe the company’s potential is great. As a result, positive sentiment and revenue growth over 100% year-over-year has allowed YY to trade higher by 191% in 2013.

Compared to Zillow, I like what I see with YY. The company is growing faster; it has an operating margin of 18%, and is therefore profitable. YY is also cheaper at 11.5 times sales. However, there is one more statistic that really jumps off the page, a number that paints a pretty picture for the company's future — spending.

Zillow spent 70% of its quarterly revenue on sales/marketing. YY spent just 2%! Yet, YY still doubled its revenue over the previous year. In my view, it is a great sign that YY is growing from popularity, and is growing the right way. It also reflects well on the company's future, as it will be able to make investments to expand and for acquisitions, rather than buying traffic on existing platforms.

Playing with the Big Boys

Yelp (YELP) is an online community of ratings and reviews for both local and global organizations. Essentially, the company makes money by selling advertisements to local businesses and branded companies. During its last quarter, revenue grew an impressive 69% year over year, and this growth that has pushed shares higher by 175% in 2013.

Those who are bullish say that Yelp can profit from a massive $2 trillion global entertainment business, and that its network of users is making it impossible for local and branded businesses not to advertise on the site. However, bears will note that Yelp is a direct competitor to both Facebook and Google, as both companies are engaged in the business of advertising.

While Google, Facebook and Yelp are completely different business models, all are fighting for the almighty advertising dollar.

Yelp is the smallest of the three, having revenue of just $178 million over the last 12 months. In 2013, Yelp produced revenue of $101 million, but like Zillow, has spent more ($106 million) on operational costs in order to generate the revenue. On the other hand, Facebook is actually cutting costs, and reported having 18 million local business accounts during its last quarter.

Clearly, Yelp has an uphill battle. It is having to compete with two power companies that have significantly greater traffic. In regards to advertising dollars, Facebook and Google are light-years ahead of Yelp, and judging by Yelp's spending, the company is doing everything possible to maintain its growth rate. With that said, I am not sold on the idea that growth is sustainable, and would not pay 18.7 times sales to take that chance.

Medical Online

Last is WebMD (WBMD), an online health information service that has produced gains of 135% in 2013 after a 70% loss between 2011 and 2013. Much like the others on this list, WebMD creates revenue from advertising, but also from sponsored organizations who endorse its online health portal.

Unlike the others on this list, WebMD is not a hyper-growth company. During its last quarter, revenue grew 11%, and just 5.4% in the quarter prior. However, lowered costs and higher margins have created some excitement, coupled with its industry-low price/sales ratio of 3.4 and an overall positive sentiment for the space, and WebMD has thrived.

That said, it does appear its large growth days have passed, and in an industry that rewards growth, investors may should go elsewhere. Furthermore, there are a lot of concerns surrounding future regulatory changes that could limit the company's medical postings, which wouldn't bode well for the stock.

Final Thoughts

In an economy that is barely growing, the massive year-over-year revenue gains from the Internet space can be very appealing to some. But like any industry, there is good and bad, as retail investors must use caution with such inflated valuations.

Zillow looks too expensive, Yelp’s competition is alarming and WebMD’s growth is only moderate. Therefore, YY is my favorite of these top performers. YY has the fastest growth, operates in a massive and underdeveloped Chinese market, is profitable and is significantly cheaper than either Zillow or Yelp. These aspects combined make YY a good stock in a risky yet promising Internet industry.


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