SINA: A "Must-Own" China Play

12/17/2004 12:00 am EST

Focus:

Gregory Spear

Editor and President, The Spear Report

Gregory Spear uses a unique approach to selecting stocks; he monitors the financial newsletter world, and looks for a "consensus" among those with the best performance. From there, he compiles a buy list of expected top performers. Here's one he calls a "must-own" stock.

"Over the last few years, investing in China has resembled a 'fad,' and as we all know, fanaticisms of any sort always cut both ways. When the game is on, performance can be outstanding, but when the herd stampedes for the exits at the first sign of trouble in paradise, group-think can drive such stocks to deeply oversold levels. In the markets, this phenomenon is called herding and it is what creates bubbles. What was once universally loved can just as easily become objects of scorn.

"SINA (SINA NASDAQ) came public in the heyday of the tech party of 1999. When the bubble collapsed, Sina fell 98% from its post-IPO high to trade at about a buck a share in October of 2001. Then, over the next two years, SINA made a spectacular climb back up the ladder to recapture former glory. Why? There was actual value there. The company was growing like a weed but had the breeding of a wild rose, as it was becoming extremely profitable. SINA then peaked again in January 2004 near its old highs along with the Nasdaq and has been in a correction since. Now,  two things are lining up to call our attention to the stock. First, having fallen 62% from its January 2004high, SINA appears to be in the process of completing that corrective process. Second, there is a clear fundamental driver behind the rally. SINA has been primarily a play on mobile wireless services. But the company is diversifying into the online gaming market and that strategy has a great deal of potential.

"The driver for the company is known as MMOGs, or 'Massively Multiplayer Online Games'. There is also a  more creative and all-absorbing variation called Massively Multiplayer Online RolePlaying Games. In the online game world, having more than 10,000 subscribers qualifies as 'massive', and there are perhaps two dozen such games being played in the world right now. They are being played mainly on desktop and laptop PCs, but they are coming to mobile platforms (smartphone & PDAs) as the wireless broadband wave moves inexorably around the globe. By the way, online gaming is not online gambling, although it is addictive and usually involves some sort of violent content. Further, we’d caution that governments in Asia have begun to enact measures to protect their youth from online excess.

"Meanwhile, SINA has 102 million registered users, 12 million active users for a variety of fee-based services, and 3.6 million gamers. Sina is just entering the gaming business, having launched the online gaming portal iGame, in July. The question for investors is how to evaluate the earnings potential of these gaming subscribers, which have until now been playing for free. While online gaming is a very high margin affair, with gross margins north of 85%, the overall market is still comparatively small, generating just $160 million in 2003. But there is no question gaming is growing exponentially. Competitor Netease, which gets 2/3 of its revenue from gaming, earned about $18 million in the last quarter from MMOGs. For the 3rd quarter, its game base grew 20% sequentially to 555,000. Sina is now trying to leapfrog NetEase.

"With a market cap just slightly larger than Netease, SINA faces the crucial task of converting 3+ million free users to paying customers. If they execute well, this will dramatically increase shareholder value. Clearly, even if they convert just 15%, they will match Netease’s current level. If Sina can grow paying gaming subscribers into the low single-digit millions, and maintain its margins, a similar market multiple would be, well, staggering. With the stock trading about 20 times this year's earnings, in a country where more than 90% of the population is still offline, we are betting that Sina will succeed. We reiterate our must-own recommendation."

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