SOHU: MOBILE CONTENT THE CULPRIT; ONLINE AD ON-TRACK
Investment Conclusion: The company reported at the low-end of revenue guidance, and EPS was in line. While online advertising was at the high-end of the guidance, mobile content was 16% less than our already Street-low estimate. With no relief in sight, Q1:07 guidance is light due to continued weakness in wireless, despite an expected sequential increase for brand advertising revenues (vs. sequential decline in Q1:06). While we believe brand advertising revenues are conservative for Q1, deterioration in mobile content remains significant and should more than offset any upside in the near-term. We expect the stock will be under pressure due to mobile content and would use the opportunity to buy in the low $20’s, as the long-term fundamentals for brand advertising remain strong, in our view. Key points are listed below.
• Brand Advertising at High-end of Guidance. Brand advertising came in strong ($22M, at the high-end of guidance, up 30% y/y) due to increased advertising activities in the Internet space. Main contributors included auto, real estate and IT verticals. This is consistent with data points we gathered recently, showing strong trends for online advertising heading into 2007. Catalysts include deregulation in key verticals, early marketing campaigns for the Olympics, growth in secondary cities, and the need for a targeted advertising platform. With that in mind, management guided for a 3-4% sequential increase despite sequential decline historically due to seasonality.
• Mobile Content Weaker than Our Pessimistic Forecast. The impact from new policies was more severe than expected, down 23% sequentially ($6.8M wireless revenue vs. our $8.0M estimate). Despite this significant decline, the company still expects further downside heading into the next quarter. This is a surprise to us, as the company has not been aggressively pursuing the wireless business compared with its peers. We checked with our contacts after the call and found that regulatory activities were strengthened in December. As a result, the mobile content operators had limited their promotional activities, causing revenues to drop off sharply. Going into Q1:07, management expects further decline, down another 20% based on non- advertising revenue guidance.
• Q1:07 Expectations Reset Due to Wireless. With no relief in sight for mobile content, Q1:07 guidance is light vs. consensus despite an expected sequential increase for brand advertising revenues (vs. a seasonal decline). While we believe brand advertising revenues are conservative for Q1, deterioration in mobile content remains significant and more than offsets any upside in the near-term. For brand advertising, management believes the growth drivers will be increased inventory such as new video channels related to sports and entertainment.
• Estimate Changes. We are lowering our Q1:07 revenue estimate from $35.4M to $33.5M and our EPS estimate from $0.23 to $0.20, mainly due to the decline in mobile content revenues (from $7.8M to $5.5M). Our 2007 estimates were adjusted accordingly from $164M in revenues to $153M (down 7%) and $1.06 in EPS to $0.97 (down 8%).
• Valuation Still Attractive, But Wireless is Wildcard. Using SOP, our price target remains at $28, implying a 27x our 2007 EPS estimate plus $2 in net cash, consistent with Sohu’s expected long-term growth rate. However, given the uncertainty in the mobile content space, we expect the stock to trade sideways in the near-term.
SOHU 1-yr chart: