Fast rising search operators Qihoo 360 (NYSE: QIHU) and Sogou may be challenging sector heavyweight Baidu (Nasdaq: BIDU) in terms of market share, but they're having far more difficulty finding an audience among advertisers that are the sector's main revenue source. That's my main conclusion after seeing the latest data for all 3 companies, which show Qihoo and Sogou making steady gains in terms of search traffic but failing to translate those gains into meaningful revenue.
The lack of progress in the revenue column by Qihoo isn't all that surprising, since the company only launched its So.com search service in the summer of 2012 and has been focused more on building an audience in its initial ramp-up period. But the lack of search revenue is a little more disappointing for Sogou, since the search engine operated by web portal Sohu (Nasdaq: SOHU) has been in business for about a decade now but has remarkably little to show for its efforts in terms of money.
Let's start with a look at the latest market share data, which show the rapid erosion of Baidu's position over the past year. According to CNZZ, the search measuring service of e-commerce leader Alibaba, Baidu controlled about 60 percent of China's search market in March, down sharply from its 70 percent share a year earlier (English article). Much of Baidu's losses went to Qihoo, whose share doubled over the same period to about 25 percent. Sogou's share also rose sharply to about 12 percent from a previous 8 percent, though much of that gain was the result of its merger last year with Tencent's (OTCPK:TCEHY, HKEx: 700) smaller Soso search service.
Now that we've looked at market share, let's turn to the latest search revenue data for all 3 companies. Baidu was the clear leader, though the magnitude of its lead was rather eye-opening. Its revenue, nearly all of which comes from search, rose around 50 percent to $1.6 billion in last year's fourth quarter. By comparison, Sogou posted a 66 percent gain in search revenue during the same period, but still only managed to reach a paltry $64 million. Qihoo didn't even disclose its search revenue for the quarter because it was too small to be meaningful, saying the search monetization process was still in the "nascent stage".
Some quick math will show that Sogou's revenue was about 4 percent the size of Baidu's for the period, even though its share of search traffic was about 20 percent of Baidu's. That means that for every dollar of search revenue that Baidu generated, Sohu was bringing in about 20 cents for comparable search traffic. I'm fairly confident that Qihoo can do better than that rate, as the company has a better track record for getting money from its businesses, even if it sometimes uses questionable tactics to do so.
The fact that Qihoo isn't giving any financials yet for its search business, combined with Sogou's disappointing performance, both look a bit disappointing and could bode poorly for both companies' stocks. The lack of ability by both to generate revenue from search, despite their large traffic share, means that Baidu remains the clear favorite for advertisers looking for the best place to put their money.
Qihoo could be most at risk if it doesn't start to show some significant search revenue soon, since the company's shares have soared in the last year on expectation that it would quickly translate its search gains into money. Qihoo's stock now trades at a staggering price-to-earnings ratio of more than 100, after its shares tripled over the last year. Of course it's also worth noting that the stock has already retreated 30 percent in the last month, as investors start to realize the hoped-for search gains may not come quite so quickly.
Sohu's shares have also fallen by a similar amount over the last month, as part of a broader pull-back for Chinese Internet stocks following a sharp rally in 2013. Look for Qihoo to lead the downward charge in the months ahead as investors slowly begin to realize that hopes for its search business may be overblown. Sohu is also likely to show similar weakness, though lower investor expectations for its search should help to limit the declines.
Bottom line: Despite their recent gains in search traffic, Qihoo and Sogou will have difficulty matching Baidu's strong ability to translate that traffic into advertising revenue.
Disclosure: No positions