For those of you who read part 1 of our analysis on Qihoo (NASDAQ:QIHU), we compared the company to Sky-Mobi (MOBI) as operating a web 1.0 business that is presently misunderstood by the marketplace. From the company's rebuttal, we conclude Qihoo is not so much like MOBI; it might be a lot more like China MediaExpress (CCME).
Our intended part 2 on QIHOO was planned to focus on the naïve analyst commentary and the dubious history of management. But all that has become a sideshow to what our research found, so hold on to your seat and call your class action attorney.
While Qihoo does in fact have penetration in the free anti-virus software business — that we do not question — the rest of the business seems to be nothing more than an illusion that defies validation by any third party source. Either Qihoo has some magic pill that neither we nor the major players in the China internet space know about, or this is a fraud.
There are a number of chilling parallels to China MediaExpress in QIHU's current business model. We suggest that investors and analysts — especially those who are quick to proclaim "Citron doesn't get it" — read this report with an open mind.
The main criticism of the initial Citron report was that we did not understand Qihoo's business model and therefore we could not draw a comparative valuation to any other business. The analysts describe Qihoo as a "master aggregator." We get that. They say they generate a lot of web traffic.
Business – n. dealings or transactions especially of an economic nature.
Giving away free software is not a business…let's call that a hobby. A business generates revenue. If you don’t believe us, just read QIHU's prospectus:
In 2008 and 2009, we generated a substantial portion of our revenues from sales of third-party anti-virus software. In the second half of 2009, we started offering 360 Anti-Virus to users free of charge as we adopted the business model of offering free Internet and mobile security products to build up a large and loyal user base and generating revenues through providing Internet services, including online advertising and Internet value-added services.
So advertising is how they generate their revenues, and that is consistent with their revenue mix disclosure last quarter.
Revenues June 2011 Qtr
$35.1 million USD
Internet value add services (mostly
games authored by 3rd parties)
$ 8.1 million
The company states that they generate this advertising revenue by posting links through their portal site.
Undifferentiated Business Model
Qihu's homepage, shown below, resembles dozens or hundreds of other web directory / navigation sites which are very popular in China. Here are just a few:
You can see they're all very similar (English speakers can get a pretty good sense of these using Google translate). In fact there's a fierce battle for domain-brand identity. In Qihoo's case, their portal is hao.360.cn. It is not hao360.com or hao360.cn, which appear to belong to others.
These sites typically focus on link traffic, not brand (display) advertising. Companies that pay for links on these are paying out of their advertising budgets - their online advertising budgets. Qihoo classifies this as "advertising revenue." We get that - do you?
Comparing to Baidu (BIDU)
Some analysts and commentators have been comparing Qihoo to Baidu. This is fatally flawed logic. Baidu also operates a directory / portal (hao123.com), but it is such a small part of the business that they don't break out its revenues or costs separately. Baidu's primary business is search, which is proven to be a highly profitable business model — at least for the winner in a winner-take-all category.
Breaking Down The Top Line
Qihoo's pre-eminent revenue generator is their flagship portal and within that domain, their PSPs (users can personalize their own start page). Linked to that are their vertical niche portal pages. Together, these sites generate 100% of Qihoo's current revenue.
Below is a screen shot of Qihoo's flagship revenue driver HAO.360.CN :
There are appx 200 links on this page. But how much revenue is generated from this site, and who is paying what? We are supposed to believe that this site is generating over $40 million revenues this quarter, and further, is growing at a rate that outstrips all the major players in the China internet space, raising serious questions about its credibility.
Below is a screenshot of the same site 21 months ago when it was generating less than $10 million per qtr. in revenues:
Feb 12, 2010 (QIHU revs of $9 million in that quarter):
And last, the same page from early 2009, when it was generating only $3 mil a quarter in online revenues:
A few less links, but essentially identical in structure and function. So exactly how did revenues increase 400% from last year and 1200% from two years ago? The quantity of links certainly hasn’t increased 400%. We have no verification that traffic has increased anything near 400%. Have the ad rates gone up 400%?
Or is this just a fraud?
For that matter, are there even verifiable ad rates for this page? Below is a list of advertisers on the front page of HAO.360 that we believe do not pay QIHOO one dime.
- Yahoo (YHOO) Mail
- Hotmail (Microsoft (MSFT))
- Amazon (AMZN)
- Vogue (Conde Nast magazine)
- Self (Conde Nast magazine)
Further, of these well-known Chinese brands, some of whom directly compete with Qihoo for games or traffic, isn't there a serious business issue requiring disclosure as to how much they are paying for links?
- Ctrip (CTRP)
- QQ Mail
- China Mobile (CHL)
- Sina (8 links) (SINA)
- Sohu (6 links) (SOHU)
- NetEase (NTES)
- Taobao (2 links)
- Youku (2 links) (YOKU)
- Dangdang (DANG)
Our favorite of the "advertisers" is West Point Military Academy (look in the "Military academies" section, left column, 4th row). Yep, that's it, right next to the link to the "U. S. National Defense University."
Qihoo recently launched an "e-commerce aggregator page" which sounds exciting.
OK, so let's look under the hood at this page. It is filled with logos of global companies you will recognize: Nokia, Samsung, Motorola, Sony, Sharp, Giordano, Reebok, Converse, Puma, Nike, Lee and many others. Ask on the conference call how much revenue this page generates for the company. We did.
Despite the lack of revenue, here's a selection of logos displayed on Qihoo's "mall" page:
The creepy thing is this is exactly what CCME's strategy was. In order to convince investors that it was a huge advertising channel, it produced a small number of copies of a very glossy catalog filled with logos from top-name brands like Coach, Lexus, and Coca-Cola.
Here are some screen shots from Citron's 3 favorite pages out of CCME's "Investor Presentation, October 2010:"
Qihoo’s other sites are the following 4 vertical portals, for group buying, video, games, mini games, and literature. They are merely aggregators and the company has told us that none of them except games represents more than 3% of revenues:
Wan.360.cn - Games
Tuan.360.cn - Group Buying
Xiaoyouxi.360.cn – Minigames
Xiaoshou.360.cn – Literature
An early sign for us that China Media Express was a fraud was simply the incredible pace that they were growing revenues and profits compared to their well-known competition.
During the trailing twelve months, both SINA and SOHU have grown their top line revenue around 23%. Both companies have diversified revenue streams and a PROVEN internet footprint. During the same trailing twelve months we are supposed to believe that Qihoo has grown their revenue 400%?
Yet, just like China Media Express, none of their pre-eminent competitors even considers them competition. Qihoo fancies themselves as competition for BIDU. Yet in its own filings, BIDU describes their competition as:
Google (GOOG) and Microsoft, and China-based Internet companies, such as Netease, Sohu, Tencent and Alibaba (ALBCF.PK).
SOHU, who recently launched a popular browser and who also sells games, lists their competition this way:
not limited to Sina Corporation (or Sina), Tencent Holdings Ltd. (or Tencent) and NetEase.com, Inc. (or NetEase), and vertical sites, such as YouKu.com Inc. (or Youku), Tudou, Inc. (or Tudou), Ku6 Media CO., Ltd (or Ku6), Pacific Online Limited (or PConline), SouFun.com Limited (or SouFun), China Real Estate Information Corporation (or CRIC), and Bitauto Holdings Limited (or BitAuto). In addition, we compete with operators of leading global websites and Internet service providers, including Yahoo! Inc. (or Yahoo!), Microsoft Corporation (or Microsoft) and AOL Inc.
SINA, who describes themselves as an internet portal and fights for ad dollars as well, voluminously defines their competition as:
Our competitors include existing or emerging PRC Internet portals as well as vertical websites competing in a specific niche such as automobile, finance and IT information. Our competitors in these areas include Baidu.com, Inc. (“Baidu”), Tencent Holdings Limited (“Tencent”), Netease.com, Inc. (“Netease”), TOM Online, Inc. (“TOM Online”), Sohu.com Inc. (“Sohu”), ifeng.com, Hexun, East Money, China Finance Online, PCAuto, Auto Home and PCOnline. outdoor media, more directly compete with traditional media, such as television, they ultimately compete with us to convert advertisers from traditional media to new media. These competitors include Focus Media Holding Limited (“Focus”), Air Media Group Inc., Vision China Media Inc. and other China-based private or public new media advertising companies…There issignificant competition among MVAS providers. A large number of independent MVAS providers, such as Kongzhong Corporation (“Kongzhong”), Tencent, TOM Online, Hurray! Holding Co., Ltd. (“Hurray”), Sohu and Linktone Ltd. (“Linktone”), compete against us. We may be unable to continue to grow our revenues from these services in this competitive environment. In addition, the major operators in China, including China Mobile and China Unicom, have entered the business of content development. Any of our present or future competitors may offer MVAS that provide significant technology, performance, price, creativity or other advantages over those offered by us, and therefore achieve greater market acceptance than us.
Our other areas of focus for future growth include WAP portal, search, online video and Web 2.0 services. We also face intense competition from domestic and international companies in these areas. The main competitors for our WAP portal include Tencent, Kongzhong and WAP portals operated by mobile telecom operators such as China Mobile’s Monternet. The main competitors for our search service include Baidu, Yahoo!/Alibaba, Google, Microsoft (Bing), Tencent (Soso) and Netease (Youdao). The main competitors for our instant messaging service include Tencent (QQ), Microsoft (MSN Messenger) and Yahoo! China (Yahoo Messenger)/Alibaba. Web 2.0 companies are defined as those that offer tools to: companies such as Baidu, Tencent, Netease, Sohu, Youku, Renren.com Microsoft (MSN), Shanda (Shanda Literature), and Giant (51.com) as well as private companies such as 56.com, Tudou, Ku6, PP Live, PP Stream, Bokee, Blogbus, Poco, Blogcn, Hexun, Kaixin001.com and hainei.com in China and international players such as YouTube, MySpace, Twitter and Facebook.
What sticks out like a sore thumb is that Qihoo says they are the #3 internet company in China by active user base, the #1 provider of internet and mobile security solutions by active user base, and sport a user penetration rate of 92%, yet the aforementioned companies list everyone as their competition except Qihoo, of course.
So we are supposed to believe that the 3rd largest internet company in China with revenues growing at 400% a year has just been forgotten about by their competition? Sounds very CCME- like to us.
Mainstream Media Attention
Exposing CCME was difficult because nowhere online was there ever a compilation or ranking of their competitive sector (video advertisers on intercity buses in China). In the case of Qihoo, there are plenty.
We scoured the internet to try to find just one list that would have hao.360.cn or any Qihoo site in their top rankings of internet traffic, to no avail. Look for yourself:
In Qihoo's rebuttal, we learn that we cannot use Alexa or Google Doubleclick to judge Qihoo's traffic, because their toolbar is incompatible with Alexa. Then who are we supposed to use? We challenge anyone to find one independent piece of research that would rank HAO.360 as a significant player. We cannot, and neither can their “competition.” Besides the commissioned iResearch report, prepared for Qihoo's IPO, are there any other lists that rank Qihoo's sites in the top 5 in China in terms of traffic?
What makes all of this even more ludicrous is just like CCME, Qihoo doesn’t even have an online media kit. Sina and Sohu both have online media kits to be explored by potential advertisers, but Qihoo’s link tells potentials to just “send them an email” - very CCME like.
But QIHU's is only this: http://hao.360.cn/mkt.html (eg. "Send us an email")
Meanwhile, Who is Counting The Beans?
We have made a strong case why the advertising revenue volume at Qihoo just does not add up – either to their competitors or us. Yet, it is in an SEC filing so it has to be true, no? In our last but most telling comparison to CCME we have the auditor.
Qihoo is audited by none other than Deloitte Touche in China. Deloitte was also the auditor of CCME and most notably, Citron-exposed fraud Longtop Financial. Anyone who follows the saga of Chinese stocks knows that Deloitte China recently refused to cooperate in an investigation by the SEC of Longtop and is being taken to federal court by the SEC.
We will follow through with Deloitte Touche and make sure their auditors are aware of the many "holes" in Qihoo's story.
What will happen when QIHU reports earnings?
Today, QIHU reports earnings. We are confident that, despite the warnings and cautious guidance from the pre-eminent Chinese internet companies, whose revenues are largely dependent on advertising, they will put up a topline number that will beat analyst estimates. This is reminiscent of CCME’s last Q in 2010 when they put up record numbers and raised guidance.
All this will be oblivious to the strong headwinds in the online advertising space in China. No one questions that SINA's Weibo is among the “hottest” internet properties in China. But last week SINA CEO Charles Chao was cautious on online ad spending as he said on a conference call, "Overall, the sentiment is good but not great based on our assessment … There may be some increase (in advertising spending), but not significant.”
So we are supposed to believe that SINA is not seeing significant increases in online ad spend yet Qihoo is able to grow their top line 30% per quarter, but no one in China seems to know about it? Which leads us to our next point.
Questions for the Conference Call
As investors, we are fortunate that QIHU will host a conference call today. Here are some questions that must be addressed as the company needs to give more transparency to their “business model”:
- Please explain what verifiable metrics besides revenue have increased 400% in the last year (as revenue has to be tied to another verifiable metric).
- Besides the commissioned iResearch report, what independent third party verification of Qihoo's reach and exposure can the investing public actually rely on?
- Who are your five largest advertisers? Where do they appear on your site, and what percentage of their revenue do they generate in aggregate and individually?
- How many of the links on the HAO.360 site are free links? What percentage of the total number of links on the site are free vs paid?
- What metrics does an advertiser use to evaluate how much to pay for a link? Why would an advertiser pay for a static link if the party they compete with, or the party whose product they sell, receives a link for free?
- Please walk investors through your site and identify the specific links and the revenue generated by the ones that substantiate $40 million in quarterly revenue.
- What is the catalyst for the next 300% increase in your revenues from here? What barrier to entry prevents others from copying your model and topping your growth?
In order to justify its current market cap, Qihoo must both make transparent its revenue growth to date, but also justify 300% — 400% revenue growth over the next year.
Citron acknowledges that Qihoo found a niche when it offered anti-virus software for free in China. Its product was downloaded by a remarkable number of China's internet population. But to become a business, it had to establish true cash flow out of something it gave away for free. Qihoo's current efforts resemble more a hall of mirrors than a roadmap to the future. Investors should be extremely wary of investing in a multi-billion dollar valuation to a story as thin as this one.
Cautious investing to all.
Disclosure: As of the date of publication, Citron is short QIHU, long SINA and SOHU. Its positions can and do change at any time without further disclosure.