Inability To Monetize Search Raises Concerns At Qihoo

  • Qihoo 360 is the second most visited search engine in China with a 30% market share, second only to Baidu.
  • Qihoo’s revenues are not following the market share penetration rate as the company struggles to translate its market share into online advertising revenues.
  • The large gap between the search market share and online advertising market share coupled with shift of focus to web games segment indicates execution problems.
  • Other Chinese internet companies such as Baidu, Alibaba Group or Tencent may possess a better opportunity than Qihoo.

Qihu monetization troubles

Qihoo 360 (NYSE:QIHU) , a Chinese security and internet services company, has experienced a 45% drop in its stock price since the March 2014 peak. Is the recent pullback in stock price a buying opportunity, or is it just the beginning of a long decline in Qihoo’s stock price? Qihoo 360 offers a wide variety of services that include security products, search engine, online advertisement, web browser, cloud storage and other internet services. In most markets that Qihoo operates in, it competes with other Chinese internet giants like Baidu (NASDAQ:BIDU), Alibaba Group (NYSE:BABA), Tencent (OTC:TCEHY) and is able to preserve a competitive position. As shown in chart 1 below, Qihoo was able to penetrate the online search market and gain a meaningful market share, second only to Baidu.

China search engine market share by volume

That penetration rate and market share made Qihoo appealing to many investors who believed that the company could compete with Baidu or at least generate revenues as quickly as it gains market share. Investors liked the opportunity to invest in a growing internet company in the fastest growing internet market in the world.

As presented below in chart 2, eMarketer projected that in 2014, the Chinese online advertising market will generate $9.5B in revenues. If Qihoo can translate its search market share measured by volume into online advertising revenues, then the company has the potential to increase revenues at a fantastic rate.

eMarketer report on China online ad spend

However, despite the expectations in Q2’14, Qihoo reported only $171M in revenues while Baidu reported $1.9B in revenues from online advertising. As opposed to the 30% share of online search market by volume, Qihoo has only a 2.5% share of the online advertising market by revenue, falling short of Baidu, Alibaba, and Tencent. Qihoo is the seventh largest player in that market by revenue, as seen in chart 3 below.

China online advertising market share by revenue

Qihoo’s biggest appeal to investors was its penetration into the search engine market and its large market share. But when search engine penetration was not translated into revenues and mobile games contributed more and more to Qihoo’s total revenues, the company lost its appeal with investors looking for the next Baidu.

As shown in chart 4, Qihoo’s revenues increased at an impressive quarterly rate of 21%. However, revenue from Internet value added services is driven mainly by web games, which increases the online advertising expense. While increasing revenues from a non-core business is a positive thing, in Qihoo’s case, it highlights the inability of the company to monetize its online presence through its web browsers, online security, and search engine presence. If Qihoo’s management were able to translate its strengths to revenues, the web games increase would have counted for much less of the total revenues as online adverting should have been much higher. The fact that the online advertising segment is not fulfilling its potential puts a big question mark over the company’s ability to monetize future products and services.

Qihoo 360 revenues

Qihoo’s stock presented a better investment alternative than the S&P 500 for a short period in which it reached a peak of $121 per share. From that point in March 2014, Qihoo’s stock dropped 45% and lost almost $50 from its price. Qihoo’s current valuation may seem appealing with a trailing P/E of 58.52, forward P/E of 16.58 and a PEG ratio of 0.63. However, difficulties to monetize search put its future in question and investors at risk.

Conclusions

Qihoo 360 seems like a great investment in theory: it has leading products in a few markets; it has a growing market share in the Chinese search market and has a strong brand in the Chinese market. All these should have helped Qihoo fight back against China’s internet giant, Baidu. However, even though Qihoo is the second largest search engine used in China, the company hasn’t been able to compete with Baidu and Alibaba Group in the online advertising market in China. Investors interested in Chinese internet companies should consider Baidu, Tencent or Alibaba Group before leaping into Qihoo.

Disclosure: Information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer's opinion about the companies mentioned in the article. Investors should conduct their due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro Financial Consulting and Analysis are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.

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