The search engine business in China is quite lucrative and many domestic companies have been trying to profit from this segment. Baidu (NASDAQ:BIDU) has established itself as the number one search engine in China, while Qihoo 360 (NYSE:QIHU), the runner up, has been looking to dethrone Baidu for quite some time now.
Baidu commands over 60% of the market while Qihoo is trying to gain market share and owns roughly 15% of the market. It was widely assumed that in order to triumph over Baidu, Qihoo was set to acquire a stake in Sohu.com's (NASDAQ:SOHU) Sogou, China's third-largest platform. This acquisition would have made Qihoo a stronger player in the segment, but any such hopes have been put to bed now as Tencent has moved in swiftly to hijack the deal.
Tencent has shelled out $448 million to acquire a 36.5% stake in Sogou. This deal will see the two companies merge Sogou and Tencent's own search engine, Soso. Soso has struggled to attract audience in the Chinese market; therefore Tencent expects this deal to strengthen its presence.
Sohu is the winner in this deal, as it has been able to land a massive investment without having to give up control over Sogou, but this doesn't mean that Qihoo and Baidu are losers. Missing out on Sogou may be a setback for the two companies, but it won't prove to be a fatal blow, and shareholders shouldn't worry yet. Why? Let's take a look.
Strong quarterly performance despite intense competition
Qihoo reported stellar growth in its second quarter as it managed to beat analysts' estimates on both fronts. The company reported year-over-year top-line growth of 108% while its earnings increased from $7 million to $33 million.
Just like Qihoo, Baidu also managed to beat consensus estimates in the second quarter. Baidu reported an increment of 39% in revenue and posted net income of $431 million.
Recently, Qihoo started offering its cloud-based security products to its users without charge. This brilliant move has enabled the company to monetize its audience through online advertising. Also, the company's launch of a brand new search engine called so.com is a step forward. Taking into consideration that the company has a broad presence in China, this move makes sense. It will allow Qihoo to leverage its popularity to capture majority of the search market share.
In addition to that, Qihoo also launched 360 Yingshi Daquan, which is a mobile version of Qihoo's search video vertical engine 360 Video. This application will allow users to browse and watch videos from Qihoo's partners on Android-based smartphones. The number of people who access Internet via smartphones is increasing and as a result, more people are accessing online videos using mobile phones. With the evolution of technology, this trend will undoubtedly continue and more people will use mobiles for accessing videos.
Looking forward, management has confirmed that they will continue to invest more money in product development and broaden their portfolio with cloud-based services.
Moving on to Baidu, the company has intensified its expenditure on acquisitions and advertising services. Baidu is looking to enhance its product offerings in order to draw more traffic to its platforms in order to gain more traction from this segment.
Also, Baidu completed the purchase of the online video unit of PPStream in the previous quarter. After the amalgamation of PPStream with iQyi, Baidu now has the country's leading online video platform by number of mobile users. In addition to that, on the back of recent growth in Baidu's mobile monetization, the company completed the acquisition of 91 Wireless and a 59% stake in Nuomi. These new purchases are expected to tighten the company's grip on the mobile market.
What about Sohu?
The collaboration of Sogou and Tencent was highly unlikely, but even the massive investment doesn't assure success. This deal will test the resilience of Tencent as the company will be required to work with Sohu chief Charles Zhang. In the preceding year, Sogou's investor, Alibaba, dumped its 10.88% stake in Sogou and if the past is any indication, the success of this tie-up is far from guaranteed.
However, from a standalone point, Sohu looks like a good investment at current levels. It reported terrific growth in the last reported second quarter results. Revenue had increased an impressive 32.5% while earnings growth came in at 69%. The stock seems a bit expensive at a trailing P/E of 32x, but analysts expect earnings to grow in the future, and that's why the forward P/E comes down to a more reasonable 25x. Looking at the next five years, analysts are expecting annual earnings growth of almost 18.5% a year. But investors should keep an eye on the ongoing war between Sohu and Qihoo. After Qihoo was spurned by Sohu, the two have entered into an ugly spat and it might be possible that Qihoo could hurt traffic to Sohu.
The Chinese Internet war is far from cooling down and it remains to be seen who comes out on top. At the moment, Qihoo is witnessing solid growth while Baidu is looking to keep its lead intact. Qihoo is busy launching new products to maintain its growth while Baidu is focused on acquisitions. Sohu, meanwhile, needs to be wary of Qihoo and a huge investment from Tencent could not be enough to keep its growth rate intact.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.