Sohu (SOHU) reported impressive topline growth across all operating segments for Q4 with total revenue growth of 42% y/y. However, gross margin was weaker than expected due to rising content and bandwidth cost, which should be expected since Sohu's acquisitions of premium video content were well-reported by the media.
Sohu's shares fell 15% during the trading day and I see this weakness as an attractive entry point due to continued upside in search, online video and microblog. I remain overweight on Sohu's shares.
- Total revenue: $246 million, +42% y/y
- Brand advertising revenue: $78 million, +29% y/y
- Sogou search revenue: $23 million, +248% y/y
- Online game revenue: $123 million, +34% y/y
- GAAP net income attributable to Sohu: $25 million, or $0.65 per share
- Non-GAAP net income attributable to Sohu: $53 million, or $1.36 per share.
- Total revenue: $852 million, +39% y/y
- Brand advertising revenue: $279 million, +32% y/y
- Sogou search revenue: $63 million, +238% y/y
- Online game revenue: $436 million, +33% y/y
- GAAP EPS: $3.93 per share
- Non-GAAP EPS: $4.96 per share
What I liked: robust topline growth across all segments.
Please see earnings summary above.
What concerned me: rising bandwidth and content cost.
In Q4, brand advertising gross margin was 58%, a decline of 2% from a year ago. Non-GAAP brand advertising gross margin was 59% compared to 63% in 4Q10. The sharp decline in gross margin was due to rising content and bandwidth cost.
While rising bandwidth and content cost is a near-term negative, I would like to point out that such decline in margin should be expected as Sohu has been ramping up its content library to take market shares away from Tudou (TUDO). I note that at the end of Q4, Sohu had 13.3% of China's online video market share, closely trailing Tudou which has 13.7% market share, according to Analysys International. I expect Sohu to overtake Tudou as the 2nd largest online video platform in China as the company invests in content expansion through a combination of acquisition and in-house development.
Unlike its US counterparts, such as Yahoo! (YHOO) and AOL, Sohu is one of the rare Web 1.0 giants whose core businesses in search and portal not only maintained their industry leadership but also successfully withstood the onslaught of emerging Web 2.0 companies in online video and microblogs.
Over the past several quarters, Sohu's brand advertising revenue has exhibited higher growth rate than that of Sina.
Despite only accounting for 3% of China's online search market, Sogou Search exhibited more robust topline growth than rival Baidu (BIDU), and its Rising Sun ad system is comparable to Baidu's Phoenix Nest. I expect Sogou's to expand its market share as Google (GOOG) gradually withdraws from China.
Sohu also successfully established strong presence in Web 2.0 territories, namely online video and microblog.
In 2011, Sohu Video saw a robust 120% y/y revenue growth. In addition, the platform commanded 21 out of 30 most watched primetime TV dramas, according to CSM Media Research.
Sohu's microblog also gained traction and accumulated 120 million users at the end of 2011, while Baidu was unable to establish a foothold in the industry and subsequently shut down its microblogging unit several months after the launch.
Recently, Sohu poached several key opinion leaders, the most critical component of Sina Weibo, to its own microblog site. Prominent economist such as Han Zhiguo began to tweet on Sohu Weibo in January and praised the platform's improvements and functionalities. As Sohu attracts additional celebrities and opinion leaders, Sohu Weibo will become an important monetization platform that advertisers will embrace.
Recommendation: I remain overweight on Sohu's shares despite the recent increase in bandwidth and content cost. I feel that investment in content is a necessary component of the company's strategy to compete against the emerging Web 2.0's and maintain its leadership in search, portal, and online video. The company's growth in search, microblog and online video offers significant upside and its current valuation of 9x 2012e EPS is fairly attractive compared to Sina and Baidu, which trade at 49x and 28x 2012e EPS, respectively.