Weakness in Weibo Stock Following Strong Q2 Numbers Is a Buying Opportunity

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Chinese internet giant Weibo (NASDAQ: WB ) recently reported second quarter numbers that were quite good. Revenues topped expectations, and so did profits. Revenue growth remained in the ~70% range. Margins were stable around 40%. User growth was robust, and the company is still adding roughly 20 million new users per quarter.

But, those strengths were overshadowed by a slightly weaker-than-expected third quarter revenue forecast. WB stock initially popped as much as 8% after the second quarter print. Now, WB stock is down about 3%.

I think this sudden reversal in WB stock and surprise weakness following strong second quarter numbers is an opportunity. It is a bit concerning to see WB stock act so weak after such a good report, especially considering the stock is down 40% over the past several months. Clearly, the market does not like WB stock here and now.

But at $80, the long-term value proposition on WB stock looks compelling. This is a 50%-plus revenue growth company with stable margins and healthy user growth.

There are also secular growth tailwinds here through the internet and consumer booms happening in China. Despite those tailwinds and big growth rates, WB stock trades at just 20X next year's consensus earnings estimate.

In other words, I increasingly see WB stock as a case of big growth converging on a depressed valuation. That combination usually results in healthy share price appreciation in a multi-quarter and multi-year window.

Here's a deeper look.

The Bad News About Weibo's Quarter

First, let's look at why WB stock is dropping after what looked like a strong Q2 print. In short, there are two big drivers behind the selloff. One, revenue growth is slowing. Two, margins compressed slightly in the quarter.

On the slowing revenue growth side, there are two components: slower user growth, and slower monetization rate growth.

Weibo's monthly active user base grew by 19% year-over-year, versus 21% growth last quarter and 25% growth last year. Meanwhile, average revenue per user (ARPU) growth slowed to 41%, from 45% last quarter but in line with last year's 40% growth rate. Overall, revenue growth slowed from 76% in Q1 to 68% in Q2. Revenue growth is expected to slow to ~50% in Q3.

On the margin compression side, it is important to note that Weibo has featured a huge margin expansion narrative for the past several years. That margin expansion narrative is now coming to an end.

Last quarter, operating margins expanded just 100 basis points. This quarter, operating margins actually compressed 20 basis points. Thus, it looks like margins are maxing out around current 40% levels.

Overall, then, WB stock is dropping because it looks like revenue growth is permanently slowing, while the era of robust margin expansion is over.

The Good News About Weibo's Quarter

In the big picture, the aforementioned negatives aren't all that negative.

Yes, revenue growth, user growth and ARPU growth are all slowing. But, that is only natural when you are growing at a 70%-plus rate. In the big picture, revenue growth is still expected to run around 50%. The platform is still consistently adding roughly 20 million new users per quarter. And, ARPU growth remains robust in the 40% range.

That isn't too shabby. Considering all those growth rates are still big, the runway for further growth ahead in Weibo looks quite long and promising.

Meanwhile, on the margin side of things, Weibo's margins couldn't go up forever. They are maxing out around 40%, which is reasonable because that is right about where Facebook 's (NASDAQ: FB ) operating margins started maxing out.

Consequently, margins topping out at 40% is only natural. Plus, the compression was only 20 basis points, and margins are still up year-to-date. The big picture is that margins aren't going down. They just aren't heading materially higher.

Overall, then, Weibo's quarterly numbers supported the fact that this is still a big-growth company with lots of growth left and a healthy margin profile. In the big picture, those are all long-term positives.

Why Weibo Stock Looks Compelling Here

I reasonably think WB stock is undervalued by about 25% currently.

Wiebo is consistently adding roughly 20 million new users per quarter. Even if that growth moderates over the next several years, Weibo should still be able to get to 600 million users in five years (roughly 10 million new users per quarter).

ARPU growth should remain healthy because it was under $3 last year. There is runway for ARPU to grow by 20% per year over the next five years to right around $7, which is close to current Twitter (NYSE: TWTR ) levels.

Meanwhile, given recent margin trends, I don't think operating margins will go anywhere over the next five years. A 40% operating margin feels like a safe and reasonable margin target for this company now and into the foreseeable future.

Assuming Weibo continues to grow its user base and monetization rates at a healthy rate while maintaining a 40% operating margin profile, I think this company can do about $6.60 in earnings per share in five years. A growth-average 20X forward multiple on that implies a four-year forward price target of $132.

Discounted back by 10% per year, that equates to year-end price target for WB stock of roughly $100, implying 25% upside from current levels.

Bottom Line on WB Stock

The market hates WB stock right now, and that is something to be both aware of and concerned about.

But, in the big picture, this is a big-growth stock trading at a big discount. Long-term, that combination should lead to healthy share price outperformance.

As of this writing, Luke Lango was long WB and FB.

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The post Weakness in Weibo Stock Following Strong Q2 Numbers Is a Buying Opportunity appeared first on InvestorPlace .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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