China Cracks Down on Weibo: Time to Sell?

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Chinese regulators recently ordered three websites -- Weibo (NASDAQ: WB), Phoenix New Media's (NYSE: FENG) iFeng, and AcFun -- to stop streaming video and audio content. The government claims that the streams weren't "in line with national audiovisual regulations," propagated "negative speech," and weren't properly licensed to broadcast news-related content.

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The government previously fined Tencent's (NASDAQOTH: TCEHY) WeChat, the biggest mobile messaging app, over similar claims. Tencent resolved those issues by licensing its streams with the government. Weibo, iFeng, and AcFun now need to apply for the same license.

Weibo shares fell more than 10% after the news broke on June 22, while shares of SINA (NASDAQ: SINA) -- which owns a majority voting stake in Weibo -- fell 8%. But both stocks recovered some of those losses by the end of the day.

Weibo remains up about 170% over the past 12 months, while SINA has rallied nearly 80%. But over the long term, will this sudden ban on video streams weigh down both stocks?

What this means for Weibo

Like many social networks, Weibo depends on live video streams to lock in users and generate more ad revenues. That dependence has risen considerably over the past few quarters. Last quarter, Weibo reported that video views rose five-fold annually, and that its number of ad customers grew 50%. It also stated that video generated "approximately 18%" of its total advertising revenues.

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Weibo also allows viewers to purchase virtual gifts for their favorite broadcasters, with the company and broadcaster splitting the proceeds. Government regulators have notably been scrutinizing these types of accounts over the past year, due to claims that they encourage illegal activities.

But Weibo doesn't just rely on independent broadcasters. It's also partnered with many media firms -- including the state-backed CCTV (China Central Television) -- which shares regular and live videos on Weibo. Videos from Alibaba's Youku can also be directly shared on Weibo, which helps the alliance between Alibaba, Weibo, and SINA counter Tencent's growth. Weibo also acquired the streaming rights for NFL short videos earlier this year.

How will this impact Weibo's growth?

Weibo's explosive rally over the past year was fueled by incredible growth figures. Last quarter, its revenue rose 67% annually to $199.2 million. Advertising revenues grew 71% and accounted for 85% of that total, while "other" revenues (including the virtual gift revenue from its live streams) rose 49% and accounted for the remaining 15% of its top line.

Its monthly active users (MAUs) rose 30% annually to 340 million, while its daily active users (DAUs) rose 28% to 154 million. Its non-GAAP net income surged 254%, while its GAAP net income rose 561%. Analysts expect its revenue and non-GAAP earnings to respectively rise 60% and 84% this year.

That's why investors were willing to pay a huge premium for Weibo, which trades at a whopping 110 times earnings. But now that the video business faces an uncertain future, it's unclear if investors will keep paying that premium.

Weibo responds with mixed messages

In a press release, Weibo stated that it was "communicating with the relevant government authorities to understand the scope of the notice," and that it "intends to fully cooperate."

In a subsequent statement to New Tang Dynasty Television in the U.S., Weibo stated that its "programmed categories" would be more strictly managed, but "non-programmed" categories of streaming media would be unaffected. Programmed categories include news media, ads, and political messages; while non-programmed categories include user-generated content.

That decision was odd, because if the goal was to censor "negative speech," regulators should target user-generated content rather than content from big media firms or companies. Therefore, it seems like the government is merely pushing Weibo to apply for the same license as Tencent for its programmed content (which generates most of its ad revenues) and leaving user-generated content alone for now -- and likely planning to review those accounts on a case-by-case basis.

Should you sell Weibo?

It's highly unlikely the Chinese government will permanently shutter all of Weibo's video services, since CCTV is one of its major partners and it could result in a major public backlash. But I believe the government will place tighter controls on Weibo, as it did with SINA's news service two years ago, which could throttle its near-term growth.

I personally bought Weibo back in January, and recently sold my shares and bought SINA instead. The reason is simple -- SINA has lower growth figures, but it still generates most of its revenue from Weibo (which it owns a 72% voting stake in) and has a much lower P/E of 26. This makes SINA a much safer play on Weibo's growth.

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Leo Sun owns shares of Sina and Tencent. The Motley Fool recommends Sina and Weibo. The Motley Fool has a disclosure policy.