Renren IPO appetite seen huge but red flags abound

When Chinese social networking site Renren goes public next week, investors will likely ignore big risks the company faces, and be lured instead by a combination of the words "China" and "social networking." Hot Chinese tech companies like Internet search engine Baidu Inc and online video site Youku.com have risen triple-digit percentages since their IPOs, whetting investors' appetites for such offerings.
--- Renren to raise about $690m in IPO next Tuesday
--- IPO would value company at $5bn vs Facebook's $70bn
And this is in a sector that is hot in the US Facebook, the biggest social network company in the world, has a market value of somewhere around $70 billion, based on a share sale currently being contemplated, making it worth more than companies such as Boeing Co.
The demand for Renren shares was clear on Friday when the company raised the expected price range of its IPO by 30 percent to $12 to $14 per share. "Appetite to invest in China right now is so strong that some investors are willing to ignore factors that they wouldn't in other markets," said Mark Natkin, managing director of Marbridge Consulting, a Beijing-based company that advises investors on China's Internet and telecommunications sectors.
Renren's IPO filings do raise a handful of very serious questions. For one thing, Renren doesn't really seem sure how many users it has. According to its April 27 revised IPO filing, the Chinese Facebook clone's monthly unique log-in user base grew by only 5 million, or 19 percent, in the first quarter of 2011 - not the 7 million, or 29 percent, it reported in its first filing only 12 days earlier.
Some investors and analysts brush off such red flags - after all China is the biggest Internet market in the world and it is growing rapidly. They justify their cavalier attitude by saying that figures reported by Chinese companies should be used for directional information and not as perfect quantitative measurements. Others say the opaque information is a big problem. Another possible risk for investors is the broad government oversight that Renren, and other companies operating in China, face.
Chinese authorities keep extremely close tabs on Internet companies, arguing that this is necessary to maintain social harmony. This led to a big bust up between Google Inc and the Chinese government last year that ended with Google curtailing its operations in the country. Renren says in the risk factors section of its IPO prospectus that this means a prohibition against posting content that, among other things, "impairs the national dignity of China" or is "superstitious."
The prospectus doesn't mention the recent Middle Eastern uprisings, which led to a crackdown on the use of certain words on the Internet in China, but it does say Renren may not post content that is "socially destabilising." If Renren fails to comply, the company says that its websites could be shut down. Clearly that could put it out of business.
Whether a social network page posting is objectionable is determined by the Chinese authorities. Renren is also required to monitor advertisements on its websites, some of which are subject to special government review before they are posted. Renren must even guard against providing services that may lead to its users finding themselves in "emotionally charged situations."
The company also said in its filings that while it hasn't conducted a comprehensive review, it found a "material weakness" and a "significant deficiency" in its internal financial controls: Renren doesn't have enough people with knowledge of US generally accepted accounting principles. It also lacks a formal policy for investing surplus cash and managing its treasury functions. That's not unusual for Chinese IPO companies. Neither is the fact that 87 percent of Renren's leased floor area did not have the proper title documents. But it all paints a picture of a company that is far from risk free.
Still, it isn't difficult to find people who will give it the benefit of the doubt. Still, while Renren has posted losses in each of the past two years, it could still be a dream growth stock. Its net revenue grew more than fivefold to $76.54 million in 2010 from $13.78 million in 2008. But there will be some who, after reading the prospectus, may wonder whether the risks outweigh the rewards.