Qihoo: Fake It 'Til You Make It

| About: QIHOO 360 (QIHU)

Last week Qihoo 360 Technology Co. Ltd. (NYSE:QIHU) updated investors with its 2012 first quarter announcement. We now have key numbers to the revenue engine ‒ browser usage.

Monthly active users of Qihoo 360's browsers were 273 million in March 2012, compared to 192 million in March 2011.

QihooThat's monthly active users … and there are supposed to be 273 million of them. This is a tough one. China ended 2011 with 513 million Netizens, growing about 12% from the prior year. Can we then estimate that it grew 3% last quarter and not be too far off? If we were to believe Qihoo, then the percentage of monthly active browser users to the total number of Netizens in China would be 52% ‒ while Baidu statistics is reporting Qihoo's browser market share to be only 21%. And if we do not adjust for China's growth, then the gap is even wider.

(click on charts to enlarge)Qihoo quarter Browser Market Share versus Baidu Source

Note that we are comparing Qihoo's "monthly active users" to the total number of internet users in China ‒ the same ratio that Qihoo presented in its prospectus:

The following table shows the monthly active users for our primary security products and platform products, both in an absolute number and as a percentage of the then total Internet users in China … ~ Prospectus

This SEC filing then shows Qihoo's 360 Safe Browser in the table. As you can see in the illustration below, its number was said to be 44% for January 2011; Baidu's statistics reports it to be 1%.

I explained this market share crisis in my previous article: Qihoo's Browser: Rosy Claims In The Middle Of A Crisis. In short, there was a "browser war" in China and Qihoo got the worst of it. Here is a recap:

Last Article Recap

Crisis? What Crisis? From Qihoo's prospectus ...

The determined fair value of the ordinary shares increased from $5.01 per share as of January 1, 2011 to $9.67 per share, based on the initial public offering price of $14.50 per ADS. We believe the increase in fair value was primarily attributable to the following factors:

• We have achieved significant business development since January 2011, which we believe contributed approximately 70% to 85% of the increase in the fair value of our ordinary shares.

o 360 Safe Browser and 360 Personal Start-up Page, two of our key platform products, achieved stronger growth in their active user base than what had been expected for the January 2011 valuation. In connection with the January 2011 valuation, we forecast that the daily active users of 360 Safe Browser would increase 42% from the end of December 2010 to 52 million in December 2011. 360 Safe Browser's daily active users reached 56 million as of March 10, 2011, exceeding our original year-end target in less than three months. In connection with the January 2011 valuation, we forecast that the daily active users of 360 Personal Start-up Page would increase 55% from the end of December 2010 to 45 million at the end of 2011. As of March 10, 2011,…

CNZZ from October to January 2011

No one is denying that market share was lost. Not even Qihoo. Here's what Qihoo had to say in their prospectus and 2011 20-F (emphasis mine):

On November 3, 2010, Tencent issued a letter to users of Tencent QQ, Tencent's popular instant message software, announcing its decision to disable the widely used Tencent QQ on computers that had installed our security products, effectively requiring users to either stop using Tencent QQ or uninstall our Internet security products. As a result, a significant number of users stopped using Tencent QQ, or our Internet security products, or both. Due to the large number of Internet users that were affected, this incident was extensively reported in the media and attracted government scrutiny. On November 21, 2010, the Ministry of Industry and Information Technology, or the MIIT, ordered that Tencent and we end the dispute, apologize to affected users and ensure the compatibility of products concerned. We lost some users in the first several days of this dispute before our user base quickly returned to its prior level. ~ Prospectus and 2011 20-F

This was widely reported. Tencent is very popular and Qihoo got beat up. Caixin Online reported,

… during hearings at the Guangdong Supreme Court, Qihoo revealed that during those 18 hours, their user base shrank by 20 million, resulting in enormous losses.

(Caixin Online, professionally translated from Chinese, original is here)

However, the questions that concerns us right now are, Did Qihoo lie in its prospectus about January 2011?

And crucial to answering that question is the answer to this one: How fast did Qihoo's user base return "to its prior level"?

I ask because ... Baidu and CNZZ both provide evidence that Qihoo's browser user base did not recover in time for the crucial month in the prospectus: January 2011. Here is a chart from CNZZ.

Date of Fall and Recovery of Qihoo

How can we be sure that Qihoo's browser market share had not returned by the key month in the prospectus ‒ January 2011? Look at the simultaneously inverse gains and losses of market share for Microsoft's (NASDAQ:MSFT) IE browsers and Qihoo's 360 browser:

mirror image trade off between Microsoft and Qihoo

As you can see, a large share of the market was suddenly available for Microsoft to pick up at the precise time that Qihoo's numbers drop. No surprise there; Qihoo itself admits to the date of this drop. But note that Qihoo takes back the numbers at precisely the same time that Microsoft loses them.

According to Qihoo, the 360 Safe Browser eventually regained its market share. According to CNZZ, Qihoo picked up 18% in March 2011 … which means that someone else had to give up their share. Who had 18% to lose? Microsoft.

In fact Microsoft and Qihoo combined had 85% of the market; all other browsers were only about 15%! Not enough for all of Qihoo's 18% market share recovery. But in any event these other, smaller browsers not only survived but their market share was relatively flat during this period. (here and here) There were no other players -- there was a nearly direct trade off in market share between Microsoft and Qihoo.

And this trade off did not happen in January 2011.

Microsoft sheds 20.5% in March 2011, while Qihoo picks up 18% this very same month. The simultaneous … mirror image trade off in market share gains and losses between Microsoft and Qihoo serve as an independent verification of the date of Qihoo's recovery. And it was not January 2011.

To believe otherwise you have to say that Microsoft and CNZZ and Baidu were all in a conspiracy against Qihoo.

Do we still need to ask if Qihoo lied in its prospectus about January 2011?

If "monthly active users" "as a percentage of the then total internet users in China" means market share, then Qihoo's presented numbers cannot be true. If the words do not mean market share, then the numbers are not useful and, given the absence of an adequate explanation, they are misleading. Qihoo said they had 44% in January 2011. Baidu and CNZZ put them down for about 1%.

Is this comedy or tragedy? Can you imagine the worst possible time to tell the best possible story?

Worst time for the best story

See the follow-up blog: "Qihoo's own January, A Month to be Cherished"

Disclosure: I am short QIHU.

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