Sina and Baidu recently deleted some user accounts to comply with new regulations in China. In this article we consider the consequences this could have for these companies’ active user bases and user engagement levels. We will also discuss the potential impact of these changes on the valuations of these companies.

See our complete analysis of Sina here | See our complete analysis of Baidu here

Why Account Deletions?

Over 60,000 accounts were deleted by several Chinese Internet companies recently to comply with new regulations in China. Of these, 23,000 accounts were deleted by Baidu and another 5,500 by SINA Weibo. Other companies that have deleted user accounts include Sina’s larger rival, Tencent, and e-commerce giant Alibaba. The key reason behind the deletion of these accounts was that they were using harmful or misleading names, which is prohibited under the new regulation. For instance, two of the deleted accounts carried the names: Come Shoot Guns and Buy License Plates. The Chinese government has mandated that users should use their real names in their accounts.

Losing user accounts due to changes in government regulation is not a new challenge for Chinese internet companies. For example, Weibo’s user base fell 9% year-on-year in 2013, primarily due to censorship of content and increased competition from WeChat. The key reason behind the challenging regulatory environment for these companies is the fact that in China, the onus on ensuring compliance of user generated content on their platforms is on them, and when the government feels that they are failing in this regard, it steps in. Companies like SINA are wary of the government’s intervention in this regard, and they therefore proactively censor user content on their website. SINA has a very efficient content censorship team. One study found that 5% of post deletions on SINA happen within the first 8 minutes, and 30% of the deletions are completed within 30 minutes of posting. Only 10% of the deleted posts are erased after a lag of 24 hours because many of them contain objectionable content in the form of code words, which are difficult to filter out automatically.

The Potential Valuation Impact

We believe that there will very little impact of the new regulation on Baidu’s valuation. This is because firstly, the number of accounts deleted by the company is minuscule, compared to its total active user base; and secondly, the removal of fake accounts will actually enhance the overall quality of its user base, allowing advertising companies to more specifically target consumers. An improvement in the quality of Baidu’s user base might actually work in its favor by improving its click through rate. This is because more real-name accounts mean that there can be more targeted advertising suited to individual profiles. For example, if the click through rate for Baidu increases to 12% by the end of our forecast period, slightly more than the 11% mark we currently forecast, there could be more than 5% upside to our current price estimate for the company.

However, increased censorship can make services like Sina’s Weibo less open, reducing the level of engagement of certain users. Before the Government decided to enforce real name restrictions, Weibo had evolved as a forum for frank debate and scrutiny of politics and society. Alarmed by the threat to political stability, the Government imposed severe restrictions on using such services. This will make users wary of posting freely and frankly on Weibo. This in turn will reduce the quality of Weibo’s user engagement and lead users to shift to other less censored sites. The impact on user engagement could lead to a decline in its market share in the online advertising space. Certain alternatives such as Zhihu, a Quora-like messaging board, are already snatching market share from Sina. The more politically charged discussions are shifting from SINA to such sites. A sustained decline in market share would negatively impact Sina’s valuation. To give some perspective, if the company’s market share falls to 2% by the end of our forecast period, compared to our current forecast of 2.5%, there could be more than 5% downside to our current price estimate for the company.

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Sina, an online media company in China, reported its Q2 2014 earnings on August 14. At $184 million, revenue increased 21% annually, exceeding company guidance. With strong Weibo advertising growth and the FIFA World Cup, Sina’s advertising revenue continued to grow strongly (29% annually) in the quarter. Non-advertising revenue continued to decline as SINA scales down its Mobile Value Added Service business to shift its resources to more sustainable and profitable growth opportunities. Non-GAAP gross margins for Q2 2013 increased 5% annually (to 60%), as the proportion of revenue from higher margin Weibo advertising increased to 38% of total advertising revenues, compared to 25% for the same period last year. In addition, there was a shift in revenue mix from low margin MVAS to higher margin Weibo VAS.

We believe that Weibo will continue to be the biggest contributor to Sina’s growth, at least in the near term. SINA listed shares of Weibo as a separate entity on the NASDAQ in April 2014, and remains the majority shareholder of Weibo. With the separate listing of Weibo, SINA intends to increase its investment in product development and marketing to further build-up the scale of its user base and to increase user engagement. Though the move may impact Sina’s consolidated results in the current year, the company believes it will help its long term growth prospects.

We are in the process of updating our $72 price estimate for Sina.

See our complete analysis of Sina here

Weibo Listing to Benefit Both Weibo and Sina

Weibo is a microblogging and social networking website that enables users to follow celebrities and share user-generated content. Launched in August 2009, Weibo started generating revenues in the back half of 2012. It earned about $66 million in 2012, which grew nearly three-fold to $188 million in 2013.

Advertising and marketing revenues from Weibo grew 99% year over year to $59.6 million in Q2 2014. The strong growth momentum was led by native ads, particularly for small and medium sized enterprises, as well as Alibaba and ecommerce merchant revenues. SINA believes that Weibo is executing well with strong financial performance, solid traffic growth and measurable progress toward building out a social commerce platform and offering native ads to large-brand customers.

The Weibo platform made significant progress in unit expansion and monetization in Q2 2014, with the monthly active user base in June growing 30% compared to the same period of last year. Additionally, Weibo’s advertising revenues from promoted feeds and for mobile terminals have both increased significantly, which is an encouraging trend that the company expects to continue in subsequent quarters.

SINA has heavily invested in Weibo since the launch of the platform. This restricted Sina’s ability to invest in its portal advertising business. Now that Weibo has been spun off as a public entity, SINA will be able to focus resources towards building and marketing mobile and video products. The contribution of mobile to Sina’s portal business has been less than 5% for the past few years and the company is aiming at tripling the percentage this year.

Remaining SINA Businesses

During Q2 2014, SINA significantly stepped up its efforts and the investments in areas of mobile and verticals for its portal business, such as finance, sport and videos. It plans to accelerate such investments in the second half of the year. The company is still in the process of finalizing its strategies for the portal business going forward, in light of the changing market environment.

Internal finance is one of the key areas for its vertical strategies that Sina is focusing on. During Q2 2014, it launched a web-based platform for selling high quality financial assets directly to individual investors supported by SINA Payment. It also entered into a joint-venture with E-House, to create China’s First Real Estate Financial Services Platform Fang Jin Suo, to tackle the mortgage-based P2P market in the country. These initiatives will help Sina build the foundation for its Internet finance strategies. The company expects to move faster in this particular area in the second half of this year.

Sina recently acquired the remaining shares of Shenzhen Zhong Wang Cai Network Technology, the operator of online lottery website Aicai.com, which is among the most popular lottery channels in China. Sina believes the acquisition will strengthen its position in the Chinese online lottery industry, which is expected to grow by 70% this year from 42 billion Yuan ($6.7 billion) in 2013. In 2010, the Ministry of Finance made online distribution a legitimate channel for authorized lottery distribution organizations. Since then, online lottery sales as a percentage of total lottery sales have increased from nearly 4% to over 18% today. We expect this to slowly converge with the online penetration in developed countries, where over 30% of lottery tickets are sold online.

In Q2 2014, Sina saw significant business boost in sports lottery during the World Cup.

Q3 2014 Outlook

- Non-GAAP net revenue between $193 million and $199 million, an increase of 7% to 11% year over year.

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