Qihoo IPO: Will Investors Feel Safe With This Chinese Browser Security Company?

| About: QIHOO 360 (QIHU)

Founded by former executives of Yahoo! (NASDAQ:YHOO) China, this young company offers Internet security products free of charge to a massive user base, which has more than doubled in two years to over 300 million. Qihoo's key product is a safe web browser in China that is rapidly gaining popularity as Internet users search for protection against increasingly pervasive and complex security threats. Qihoo (NYSE:QIHU) plans to raise $139 million by offering 12.1 million ADSs at a range of $10.50 to $12.50. UBS Investment Bank (NYSE:UBS) and Citi (NYSE:C) are the lead managers on the deal, which is on the IPO calendar for the week of March 28.

Originally a reseller of third-party anti-virus software, this young company now offers a suite of proprietary Internet security products under the "360" brand. Qihoo's strategy is to attract users by offering free security products and monetize them by driving traffic to its secure web browser, which is second only to Microsoft's (NASDAQ:MSFT) Internet Explorer in usage. 360 Safe Browser, which was launched in late 2009, is based on an "open" platform and therefore able to host applications from third-party game developers and e-commerce firms. It generates revenue from online advertising (paid links, automatic search referral fees; 67% of 2010 sales) and additional Internet value-added services (web games, technical support; 26%). Qihoo's top-line jumped 79% to $58 million last year, driven by a 179% increase in online advertising to $39 million and a boost in Internet value-added services to $15 million (from $2 million). Adjusted operating margins improved modestly to 23% as a favorable mix shift from the discontinuation of its lower-margin reselling business was offset by heavy R&D investments.

Qihoo carries execution risk as a young company that only recently transitioned from a traditional software reseller model. Continued growth hinges on its ability to monetize a higher percentage of its 328 million security product users; only half (172 million) employ 360 Safe Browser, its only revenue-generating product. Other concerns include the company's increasing dependence on Google (NASDAQ:GOOG) (21% of 2010 revenues vs. 11% in 2009) and current involvement in several lawsuits mostly related to unfair competitive practices with other Chinese Internet companies (e.g. Tencent (OTCPK:TCEHY), Baidu (NASDAQ:BIDU)).

Going forward, Qihoo targets aggressive growth by adding further capabilities to its browser, expanding security product offerings, growing its mobile segment and entering new geographies. Though Qihoo is still a small player in a competitive industry, its unique method of leveraging its dominance in security to segue into fast-growing Internet services has proven highly effective thus far. The company is also led by experienced executives, and its reputable venture backers (e.g. Highland Capital Partners, Sequoia Capital, CDH Venture Partners) plan to invest another $50 million in a concurrent private placement. Coupled with a valuation that appears reasonable for a high-growth company (49x 2011 earnings), Qihoo 360 has the potential to follow in the footsteps of recent Chinese Internet IPOs Youku.com (NYSE:YOKU) and E-Commerce China Dangdang (NYSE:DANG).