$80 million for UGC Net

Share Renren (RENN), China’s largest real-name SNS, acquired 56.com, a user generated content (UGC) site in China, for $80 million in cash. The company expects the acquisition to complete by 4Q11. As of the most recent quarter, 56.com, with 66 million active users, had a net loss of $500,000.

56.com could be a double-edged sword for Renren. The site allows Renren to enter the fast growing online video advertising market, but also could negatively impact Renren’s cash reserve as it bids for professionally produced content (PPC), such as movies and Chinese soap operas. In addition, the synergy between online video and social networking sites is still unproven, which raises the question of whether this acquisition can create shareholder value.

China’s online video advertising market is experiencing tremendous growth due to gradual acceptance by both multinational and local companies. According to the most recent quarterly filings, Youku (YOKU), Tudou (TUDO), and Sohu (SOHU) reported 178%, 166%, and 150% y/y revenue growth respectively in their online video units. Meanwhile, the three largest players account for approximately 50% market share, implying a significant growth potential for Renren to become a competitive player.

However, the main driver behind revenue growth lies in user traffic, which is driven by PPC rather than UGC. To compete in the online video advertising space, Renren has to acquire PPC that can attract Chinese viewers and generate viewer traffic on 56.com. Recently, Youku, Tudou, and Sohu all expect content acquisition costs to increase by 200% in the foreseeable future, and it is questionable whether Renren, which just became profitable, has enough financial resources to scale up 56.com and be competitive.

Finally, the synergy between Renren and 56.com is still murky. Renren’s CEO Joesph Chen never specified how 56.com will be integrated into the social networking site, so this deal could prove to be a bad imitation of Facebook’s entry into online video via partnership with Warner Brothers to show "Dark Knight" on the social networking platform. At best, this acquisition will increase Renren’s user base, assuming that not all of 56.com’s 66 million subscribers have Renren accounts, but beyond that many questions remain as to how 56.com can be accretive to Renren’s future growth.

Going forward, Renren will face challenges in monetizing both the social networking platform and 56.com. Without a well-defined plan to create synergy between the two sites, this acquisition could potentially destroy shareholder value.