A $4 billion valuation for a company that made a $7.7 million profit sounds laughable, but it could be paving the way for a flurry of mind-boggling offerings.
By Kevin Kelleher, contributor
A few years ago, a cynical editor I knew was fond of challenging reporters to write a credible and printable headline combining the words “sex,” “iPhone” and “Obama” – three of the sweetest pieces of linkbait at the time. As far as I know, no one ever followed through.
Recently, we’ve seen another trifecta of key words that is almost as alluring: “IPO,” “China” and “Facebook.” As in, “The Facebook of China files for an IPO.” Such headlines started appearing last Friday, when RenRen, a Beijing-based social network with 117 million users, filed for an initial public offering on the New York Stock Exchange.
But can RenRen credibly be called the Facebook of China? And more importantly, given the growing and seemingly insatiable appetite for profitable social-media startups, is RenRen a viable IPO candidate? After a read through the company’s prospectus, the initial answer to both question seems to be, Yes.
Like Facebook, RenRen started out a social network that encouraged people to use their real identities, then added social games and e-commerce features for outside businesses. And like Facebook, its platform is open to developers creating third-party apps and it offers a Connect program letting users share content from more than 600 partner sites.
In fact, in some ways RenRen resembles Facebook so much that it frets in the risk-factors section of its prospectus about patent litigation. After noting that Facebook has a number of social networking patents, RenRen said that “there may be patents issued or pending that are held by others that relate to certain aspects of our technologies, products, business methods or services.”
Facebook has been blocked in China, except for the 400,000 or so accounts set up through end runs like virtual private networks. So RenRen’s growth has been rapid. In 2010, its revenue rose 64% to $76.5 million after more than tripling in 2009. Growth should continue for some time: According to comScore, 38% of China’s internet users visited social network sites in April 2010, versus 81% in the U.S.
RenRen’s users are active. In March, some 31 million people logged in, spending an average of seven hours on the site during the month. To date, they have posted an aggregate 2.9 billion photos, 249 million blogs and 20.8 billion comments or reviews.
Another interesting difference from Facebook, only 42% of RenRen’s revenue is coming from ads. An even larger portion, 45%, come from online games, so in that sense RenRen is more Zynga than Facebook. But either way, it’s a thriving social networking company.
In short, the good news is RenRen is a successful version of Facebook, one poised for years of growth. Now for the bad news.
For both of those reasons, RenRen is going to be expensive. The company’s IPO is valuing the company at $4 billion, assuming it debuts in the middle of the $9-$11 per share (ADS to be accurate) range underwriters have given the company. RenRen had $76.5 million in revenue last year and an operating profit of $7.7 million. So the IPO will have a price-to-revenue ratio of 52 and a price-to-operating profit ratio of 519. (For comparison, Google’s price-to-revenue ratio has been hovering around 5.5-6.5 for most of the last year and its market-cap-to-operating-profit-ratio using data for 2010 is 15.6.)
And RenRen could get even pricier. Underwriters – led by Morgan Stanley, Deutsche Bank and Credit Suisse – have a greenshoe option to sell another 8 million shares if demand is high. And, if demand is really high, it can ratchet up the price per ADS of the IPO, which often happens with the most sought-after offerings. Both moves could leave RenRen’s market value well north of $5 billion by the time the shares start trading.
In a different market, a price-sales ratio of 50 would be laughed out of the IPO pipeline. But in this one, it could be so much catnip to investors who have been shut out of Facebook shares traded on private secondary markets. Facebook shares on SharesPost have been trading close to a $80 billion valuation, or 40 times its reported $2 billion revenue in 2010.
Even as RenRen is using this IPO to float its shares into the U.S. market, Wall Street seems to be using it to float a trial balloon. More so than Pandora or LinkedIn, RenRen could be the web IPO that sets the market’s tone for the next year. It could come to be seen as a kind of test run for Facebook itself.
If investors line up for RenRen’s shares, high valuations and all, it could pave the way for an obscenely lucrative Facebook offering. And it would offer evidence to underwriters of a deep hunger for any social-network-themed startup with a promise of profits. But a good IPO needs more than growth and profitability, it needs a price in sync with common sense.
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