Weibo: Fundamentals Point To Strong Upside

Summary

• Weibo is a leading social-media company in China operating one of the country’s most successful and popular communication platform.
• With a >500 million user base and a strong brand, Weibo appears well-positioned to capture a large share of China’s internet/communication market.
• Looking at Weibo’s valuation, the company’s financials appear highly underappreciated – as Weibo is profitable and the company’s balance sheet healthy.
• I assign a BUY rating to Weibo stock and set a price target of $43.56/share.

Thesis

As investor sentiment towards China-based companies has been completely crushed in the past 12-15 months, I believe now might be a good time to hunt for bargains. I advise to look for profitable companies with a strong competitive moat and/or client base. That said, one name that I particularly like is Weibo, China’s Twitter-like social media company.

In this article, I argue why I believe the company is a Buy. I support my thesis with a residual framework based on analyst consensus and calculate a fair base-case target price of $43.56 share.

About Weibo

Weibo is a leading social-media company in China operating one of the country’s most successful and popular communication platform. Arguably, Weibo is very similar to Twitter as the company offers users an outlet for public self-expression and social interaction. That said—like Twitter—Weibo has become one of the most important sources for real-time information and news. Most notably Weibo recorded 573 million active users as of December 2021, with approximately 85% of users seeking access the Weibo platform through mobile devices. Weibo’s primary revenue source is based on advertising such as brand and product placements. Weibo first sold shares to the public in April 2014. Since 2021, Weibo has also been listed on the Hong Kong Stock Exchange.

Weibo’s opportunity

With a >500 million user base and a strong brand, Weibo appears well-positioned to capture a large share of China’s internet/communication market. In the past years, Weibo has less focused on monetization than on user growth and engagement. And in fact, the strategy appears effective. In Q1 2022, Weibo recorded a net addition of approximately 52 million monthly and 25 million daily users—indicating that Weibo is still growing >10% year-over-year. Moreover, Weibo has recorded strong investments in recommendation algorithms and video content to softly convince users to spend more time on the platform.

That said, there is lots of upside potential for Weibo to significantly increase monetization of the company’s user base. According to Bloomberg research, Weibo’s annual ad revenue per user is significantly below peers such as Tencent and Facebooks, approximately $8 vs $16 and >$60 respectively. (Source: Bloomberg Terminal, Industry Intelligence Primer, May 2022)

Personally, I also like that Weibo is trading very cheap vs historical levels. Weibo stock is down more than 80% from ATH in 2018 and is now trading at a 2023 forward P/E < x7. Most notably, the current P/E multiple implies a 2 standard deviation discount to Weibo’s historical 2-year average multiple of 14.8x.

Financials

Looking at Weibo’s valuation, the company’s financials appear highly underappreciated. From 2018 to 2021, Weibo’s revenue has grown at a CAGR of approximately 10%, from $1.7 billion to $2.26 billion. Notably, Weibo is also very profitable. In 2021, Weibo recorded a net-income margin of 34% and generated total net-income of $781 million, or $3.39/share. Cash from operations of $814 million was even higher than net-income, indicating high-quality earnings. Investors should note that the profitability was achieved despite expensing approximately 20% of revenues ($430 million) in R&D. Weibo ended the financial year 2021 with $3.2 billion of cash and cash equivalents and $2.5 billion of total debt.

Going forward, analysts expect Weibo to continue to grow. As of early 2022 estimates, the company will generate $2.33 billion in 2022, $2.54 billion in 2023 and $2.68 billion in 2024, indicating a slightly above nominal GDP 3-year CAGR of approximately 4%. EPS is expected to be $2.63, $3.00 and $3.34 respectively. (Source: Bloomberg Terminal)

Valuation

I believe a discounted earnings framework is the best valuation method to challenge the share price of an established business with high earnings such as Weibo. That said, I have constructed a Residual Earnings framework based on the EPS analyst consensus forecast until 2025, a WACC of 10% and a TV growth rate equal to nominal GDP growth of 3.5%.

I have also enclosed a sensitivity analysis based on varying WACC and TV growth combination, so investors can value Weibo based on the scenario that best reflects their fundamental view. For reference, red cells imply an overvaluation, while green cells imply an undervaluation as compared to WB’s current valuation.

Based on the above assumptions, my valuation estimates a fair share price of $43.56/share, implying 96% upside.

Risk

I would like to highlight the following downside risks that could cause Weibo stock to materially differ from my price-target:

First, investors should monitor competitive forces in China’s fast-changing social media industry – referencing players such as Bilibili, Douyin and Kuaishou. If competition increases more than what is modelled by analysts, profitability margins and EPS estimates for Weibo must be adjusted accordingly.

Second, a significant economic slowdown in China, due to COVID lockdowns, the real estate crisis and inflation, could significantly impact Chinese businesses’ willingness and ability to spend money on Weibo’s advertising platform.

Third, much of Weibo’s share price is currently driven by investor sentiment towards risk assets, ADRs, and China equities. Thus, investors should closely monitor the market sentiment when taking buying/selling decisions for the stock.

Fourth, and perhaps most importantly, Weibo is exposed to significant regulatory risks and arguably also censorship. While the impact of regulations has been relatively neglectable for Weibo’s business profitability so far, investors should definitely monitor the situation closely.

Conclusion

Weibo is one of my favourite China-based investment ideas. In my opinion, the stock is cheaply valued as WB stock sold-off more than 80% from ATH and is now trading at very attractive price multiples. It is true that regulatory exposure in China and partial censorship limit the potential of the platform from a creative perspective. However, the exposure doesn’t necessarily translate into loss of competitive positioning, and neither does it impact business profitability. That said, I assign a BUY rating to Weibo stock and set a price target of $43.56/share.

Author: Cavenagh Research, Seeking Alpha