Sohu's (NASDAQ:SOHU) stock price dropped more than 25% in just one month. Many weary investors might see this as a time to get out of the business fast; however, I see it as a 25% off sale for Sohu stock. Sohu currently trades at bargain basement prices, and any smart investor who buys at these levels will be rewarded with large returns.
Sohu currently has $1.3 billion in equity, with a large proportion of it being in cash. The company currently is valued at around 1.8x its book value -- which is a relatively low price-to-book valuation when compared to similar Chinese internet companies.
|Company||Price to Book Ratio|
Sohu has one of the lowest price to book ratios, while Sina has the largest. However, Sohu is the most attractively priced, after you factor in the growth rate of each company (Sohu grows at around 25%, Sina 10% and, Renren 8% - expected to decline in FY 2014). Furthermore, the company has no debt and has enough liquidity to either survive major problems, or invest capital into expanding the company's operations.
Major Growth Opportunities
Sohu's current P/B ratio of 1.8x is a highly conservative valuation that does not account for the company's future growth prospects, nor does it account for the company's expansive business operations.
The following is a list that illustrates the major growth opportunities for Sohu.
TV.Sohu is Sohu's online video division. Similar to that of YouTube (NASDAQ:GOOG), TV.Sohu is a site that allows users to upload and watch content. Sohu's consumer video division primarily generates its revenue from in-video advertisements and banner advertisements.
Online video is one of the largest Internet market segments in China, with over 289 million users, according to the China Internet Network Information Center (CNNIC). Online advertisers will continue to shell out more cash as more and more Chinese internet users shift from the traditional television set to internet video. Thus, Sohu's internet video stands to directly benefit from this paradigm shift as advertisers spend more and more money on this new phenomenon. In fact, Sohu has already benefited from increased video advertising spend, with Sohu's video advertising revenues growing by 123% year-over-year. With the large growth in internet video, it can be expected that TV.sohu will become a major revenue stream for Sohu.
2. Online gaming and Changyou.com
Sohu currently owns a controlling stake in Changyou.com (NASDAQ:CYOU) -- an online gaming company. The company has a large portfolio of Massively Multiplayer Online Games (or MMOG's). Furthermore, Changyou operates one of China's most popular MMOGs, TLBB. Changyou has seen growth well into the double digits (at around 28%).
Online gaming is a major market for Sohu, with consolidated revenue growth at 44% for FY 2013, and 54% growth for FY 2012.
3. Online Search and Sogu.com
Sogu is Sohu's search engine that has interest from the likes of Alibaba (part of Yahoo Japan (OTCPK:YAHOF)) and Tencent (OTCPK:TCEHY) -- two large Chinese internet companies. Thus, a large vote of confidence has been put on Sogu, and can potentially be expected to do well in the future.
Online search can be expected be a major driver of growth for Sohu, with over 44% growth in FY 2013.
Fair Valuation of Sohu
It is reasonable to assume that Sohu can grow sales at around 10-25% compounded annually (even this growth rate can be considered conservative as FY2013 growth would account for around 2 years of our estimated 10-20% compound growth rate). If the company is able to continue at our estimated growth rate for 5 years (I chose to be on the conservative side and not project to far into the future), we arrive at the following possible valuations:
- $65 per share valuation on the low end of our estimates, accounting for only 10% annual sales growth (well below Sohu's past sales growth of 40% and Sohu's expected future sales growth) and 10% net profit margin (well below Sohu's average of 20%). We then multiply the net profit by 15x P/E (average S&P P/E), and discount that number to the present using an 8% discount rate.
- $93.92 per share at the median of our estimates. We assume 17% annual sales growth, 10% net profit margin. We multiply the net profit by 15x P/E and use an 8% discount rate.
- $130.67 per share valuation on the high end of our still conservative estimates. We assume a 10% net profit margin, 25% annual sales growth. We use a 15x P/E and a discount rate of 8%.
Only at the low end of our already conservative estimates, is Sohu fairly valued; however, at the high end of our estimates, we discover that Sohu is significantly undervalued at its current share price.
Sohu is a growing company with major revenue growth in multiple subsidiaries. Furthermore, the company's current valuation suggest a company with no revenue growth and a slowing and/or declining business. However, based on the points listed above, it is clear that this is not the case. Investors who buy into Sohu will be rewarded with significant returns when the market realizes Sohu's true valuation.
Disclosure: I am long SOHU and RENN. 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.