Qihoo Tech: Behind the IPO Moonshot

| About: QIHOO 360 (QIHU)

On Friday, April 1, 2011 Qihoo 360 Technology’s (NYSE:QIHU) closing market cap was $3.5 billion, up 159% from the price range mid-point market cap on Monday of $1.35 billion, at an $11.50 share price. On Wednesday, QIHU IPO’d at $14.50 and later in the day almost touched $36. The stock closed Friday at $29.50

Perhaps QIHU will ask how their underwriters could make such a big pricing error. The answer is supply and demand, of course.

Moonshots seldom, if ever happen, with IPOs in the $500 million and higher range. That’s because with larger IPOs, investment bankers can more easily judge institutional demand. QIHU’s IPO on Monday, at the price range mid-point, was only $139 million, on the smaller side.

Three previous China deals are still trading below their IPO prices, Zuoan Fashion Ltd. (ZA), Trunkbow International Holdings Ltd. (NASDAQ:TBOW) and BCD Semiconductor Manufacturing Ltd. (NASDAQ:BCDS). Plus, there have been well publicized accounting issues with some Chinese companies.

So investment bankers wanted to make sure the QIHU IPO got done. Their initial price range mid-point valued QIHU at 84 times annualized earnings for the December quarter and 154 times earnings for the 12 months ended December 31, 2010, which seemed reasonable at the time.

However, at Friday’s closing, QIHU sold at 407 times trailing 12 months, and 216 times annualized earnings for the December quarter. What happened?

The initial spike the day of the IPO (Wednesday) was probably generated from ‘buy at the market’ orders, in general not a good idea in the immediate IPO aftermarket. Holders of the stock at the end of the week were apparently willing to pay a very high price for a Chinese Internet market leader.

QIHU knows how to monetize Chinese internet eyeballs through advertising and, at the same time, maintain very high gross profit margins and net profit margins, 88% & 20% respectively for the December quarter -- a tough proposition. QIHU also impressed investors with 71% of its December quarter’s revenue generated by advertising.

What’s next? QIHU is walking on a very high wire, where a misstep can be costly to investors. It will be interesting to see March quarter results. Based on how QIHU’s stock is acting, results better be on the blowout upside. If not -- look out below.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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