American activist investors rarely try to influence Chinese companies, but U.S. hedge fund Aristeia Capital recently went against the grain by challenging SINA (NASDAQ: SINA), one of the oldest internet companies in China. Aristeia owns a 3.5% stake in SINA, making it the company's fourth-largest shareholder.
Aristeia wants SINA to expand its five-member board of directors into seven seats with two of its own nominees. It claims that the current board is too "entrenched", and caused "critical governance failures" which caused the stock to be undervalued.
Aristeia insists that SINA should maximize the value of Weibo (NASDAQ: WB), the high-growth social media platform which SINA spun off in an IPO in 2014. SINA owns a 46% stake and 72% voting share in Weibo, which generates the lion's share of its revenues.
Aristeia suggested that SINA merge with Weibo again (via a reverse merger), sell its stake in Weibo and return the cash to shareholders with buybacks, or sell itself to the highest bidder. SINA dismissed all these ideas, declaring that Aristeia was only interested in "implementing a short-term and self-serving agenda."
Understanding the relationship between SINA and Weibo
Shares of SINA rallied more than 90% this year, but Weibo shares surged nearly 160%. That disparity was mainly caused by SINA's aging portal business, which grows at a much slower rate than Weibo.
Last quarter, SINA's portal revenues rose 9% annually and accounted for almost 30% of its revenues. Advertising at those portals dipped year-over-year, but non-advertising revenues (from value-added services) offset that decline.
Meanwhile, revenues from Weibo surged 72% and accounted for over 70% of SINA's top line. Both advertising and non-advertising revenues soared as the microblogging platform's monthly active users (MAUs) rose 28% annually to 361 million.
As a result, SINA posts slightly slower growth than Weibo. Analysts expect SINA's revenue and earnings to respectively rise 46% and 103% this year, while Weibo is expected to post 66% sales growth and 99% earnings growth.
Mismatched valuations and share distributions
As Weibo shares started outperforming SINA shares, the valuations at the two companies became distorted. Weibo now has a market cap of $23 billion, while its parent company has a market cap of just $8 billion.
This led many investors to argue that SINA was undervalued based on its stake in Weibo. SINA responded by distributing its own Weibo shares to investors with two 1-for-10 distributions -- meaning that an investor who originally owned 100 shares of SINA will now own 20 extra shares of Weibo.
But some investors, like Aristeia, see these distributions as temporary fixes which merely reduce SINA's stake in Weibo. That's why Aristeia argues that it would be more reasonable for SINA to simply merge with Weibo again, or for SINA to sell off the entire stake and use that cash to become a "mature tech" play supported by big buybacks or dividends.
But it's not that simple...
However, taking an activist position in a Chinese company is complicated. First, Aristeia, like all foreign shareholders, doesn't directly own SINA shares. Instead, the shares are purchased through a VIE (variable interest entity) which sells the shares through a holding company.
Legal experts have warned that VIEs might not be recognized in Chinese courts, which could nullify Aristeia's case. However, Chinese courts are still obligated to honor VIEs, since recklessly voiding them would likely cause big foreign investors to dump Chinese stocks.
Lastly, Weibo's growth could slow down in the near future due to the recent ban on its streaming videos, a privacy dilemma involving real names, and numerous clashes with content creators and third-party news aggregators like Toutiao. In light of those challenges, SINA's P/E of 38 looks much safer than Weibo's P/E of 121 -- which should limit its downside as Weibo drops.
Will anything change?
U.S. activist investors have won a few victories in Asia before, but they haven't had much success in China. SINA stated that it reviewed Aristeia's two board nominations, but that those extra seats wouldn't enhance the experience or skills of the current board. However, it stated that it would put the board's recommendation up to a vote at its next annual meeting.
It seems unlikely that Aristeia will get much further with SINA, unless it buys a lot more shares. But doing so would likely trigger a conflict with Alibaba (NYSE: BABA), which owns nearly a third of Weibo. Therefore, I believe that Aristeia's arguments seem premature and naive, and that it's doubtful that SINA will actually implement such drastic changes in the near future.
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