Sohu.com Inc. (SOHU) is one of the pioneers in China's Internet industry. Currently its main business includes its online gaming, search, online video, portal and wireless businesses. At $36 per share, SOHU's market capitalization is less than $1.4 billion. This valuation seems to be very low and reflects the market's negative sentiment about the company.
SOHU owns 68% of Changyou.com Limited (CYOU) and this stake alone is worth $843 million. Also, at the end of Q3/2012, SOHU had $547 in cash after netting out CYOU's portion. So SOHU's market cap is equal to its stake in CYOU plus cash. Buying SOHU at this price, investors basically only pay for the online game business, while getting all the rest of SOHU's businesses for free.
SOHU's online game business is very solid. Its online gaming operating arm, Changyou.com just reported another great quarter. But how about SOHU's other businesses? Are they really worthless? Let's take a look.
SOHU's search business, Sougou, seems to be doing just fine. In the most recent quarter, both Sougou's search market share and traffic were up; its cost per click (CPC) was up 50%. As a matter of fact, Sougou's revenue has been growing rapidly in the last three years. The chart below shows its revenue and growth rate. Based on the Q4 guidance given by management, search revenue is expected to reach $127 million in 2012, with a growth rate of 102% over 2011. Yes, it's still very small compared to Baidu, Inc. (BIDU), but its growth rate is much faster than BIDU's 55%.
Unit: Thousand USD
Investors seem to worry about Sougou's prospect after Qihoo 360 (QIHU) entered into the search market. In my opinion, QIHU's entry won't affect Sougou significantly because of the so-called "Three-stage Rocket" strategy Sougou has adopted all along. The Pinyin Input system, Sougou's own browser and superior user experience have created a moat around its search business.
SOHU's management seems to have high hopes for Sougou. Recently SOHU bought back 10.88% of Sougou shares from Alibaba for $25.8 million. This deal increased SOHU's ownership to 73%.
In the most recent quarter, Sohu Video is No. 2 in China's online video market in terms of active users. But it seems the business is struggling a bit in terms of revenue. SOHU did not break out its video business for 2012 so we have to use our own estimate. SOHU's total brand advertising revenue for 2012 will be about $289 million based on its Q4 midpoint guidance. Assuming brand advertising other than video and 17173.com will decline about 2%, SOHU's online video revenue will be about $68 million for 2012, which translates into a growth rate of only 17%, much lower than the industry growth.
Total Brand Ad.
Other Brand Ad.
Online Video Ad.
Online video Ad. Growth
Unit: Thousand USD
I believe this underperformance may in part be because of the recent corporate restructuring. From the beginning of the year, SOHU has gradually separated its Sohu video business into a separate company for a potential IPO in the future. The separation process was completed at the end of Q3/2012. Now SOHU video has its own dedicated sales team, a better incentive scheme and a clearer execution strategy. All these lay a solid foundation for much better performance in Q4 and 2013. The addition of a key executive from Phoenix TV will help as well.
From a long-term perspective, China's online video industry is very attractive. Not as it is in the US, China's TV programming is highly regulated and thus lacks variety; viewers constantly look for alternatives to entertain themselves. This creates a great opportunity for online video companies.
In the most recent quarter, China's online video industry sales were $422 million, with year over year growth of 37.2%.
The profit prospect for the online video industry has also improved significantly lately. Recent consolidation in the industry has resulted in a significant drop in content acquisition cost.
SOHU's portal includes sohu.com, 17173.com and focus.cn, a real estate website. 17173.com was sold to CYOU at the end of 2011. SOHU's portal business has been quite stable over the years with decent profit margins. It also plays a very important role in SOHU's matrix strategy by directing traffic to SOHU's other businesses.
The brief examination of SOHU's other businesses seems to indicate that they are doing fine overall. The search business is growing rapidly and will continue this momentum going forward; the portal business is stable, albeit may decline a bit because of the softening economy; the online business is struggling lately but growth should accelerate in 2013. All in all, they are not at all worthless.
I believe SOHU is under valued at a P/E ratio of 17 and P/B ratio of 1.3. The sum of its various parts is much bigger than SOHU's $1.4 billion market cap. In addition, I believe the market doesn't appreciate SOHU's so called "Matrix" strategy. SOHU's businesses are at different stages in terms of product life cycle and they are in different segments of the Internet industry. As China's Internet industry gets more volatile and competitive, this kind of combination can offer stability and sustainability for the company.
For investors looking for low risk play in China's Internet industry, SOHU is a great candidate.