A lot of criticism has been heard regarding Qihoo 360 (NYSE:QIHU), mainly from Citron Research. Citron claimed QIHU committed fraud and that the company's portal cannot generate the revenue the company claims. The company, on the other hand, claimed that it is able to generate tremendous growth in its income as the user number of its website is increasing rapidly and, as such, it is able to charge higher and higher amounts for its banners every quarter. We don't believe this is true.
We believe QIHU might be creative in measuring its size in the directory market (73% of income), income and growth rates. Our belief is based on the following:
1. QIHU ceased in Q1 2011 to use IResearch to quote its market share for its main income generating products and continues to quote IResearch only for market share for its free products. No third-party verification since Q1 2011.
2. IResearch's own research claims the directory market is saturated and that QIHU's directory site grew by 2.9% in the first 10 months of 2011, while QIHU claimed growth of approximately 100%.
3. Major Chinese websites appear not to generate traffic from QIHU's websites, indicating its actual market share might be less than what it claims.
QIHU claims to use its free security software and browser to attract users to use its other products in order to generate ad revenue. One of these other products is QIHU's Personal Start-Up Page (hao.360.cn), which generated about 73% of the company's income in 2011.
Many investors feel comfortable with QIHU's financial reports as QIHU routinely quotes third-party research to confirm its market position and user growth rates. In its registration statement in 2011, QIHU relied heavily on market research conducted by a company named IResearch Consulting Group -- a company owned by Focus Media (NASDAQ:FMCN) -- in order to confirm the following information (as of January 2011):
- It had 328 million active Internet security users;
- it had 339 million active Internet users;
- it was the No. 1 Internet security product in China;
- it was the No. 1 mobile security product in China;
- it was the No. 2 web browser in China, after IE; and
- it had 98 million monthly active users in China of its Personal Start-Up Page.
Note that the only significant revenue generating product in this list is the Start-Up Page (to be more precise, the company used to sell the security product but changed to a free distribution model a couple of quarters ago).
In its Q1 2011 report, QIHU still used IResearch to quote its Active User Numbers. Starting with Q2 2011, the company ceased to mention that the Personal Start-Up Page (its main income driver) figures are based on IResearch, but only quoted IResearch for its active browser users and the browser penetration rate (which are not the big income generators). The information on QIHU's Unique Visitors on QIHU's website and the clicks on the website have since Q1 2011 not been publicly verified by IResearch. In addition, the company stopped to use "Active Users" as a reference to its growth and changed it to "Daily Unique Visitors":
Click to enlarge images.
We believe many investors seek comfort in the IResearch "confirmation" when investing in the stock. However, it is important to note that this "confirmation" is only for the market penetration of the web browser and security products (free products) and not for users on its revenue generating Start-Up Page (73% of income as of 2011). There is no third-party confirmation for QIHU's growth rate in its revenue generating income sources.
In addition to these findings, IResearch published in December 2011 a report titled "China Directory Website Market Research 2011." In this report IResearch cover the directory market (from which QIHU generates most of its revenues). As IResearch is quoted all over QIHU's PR announcements and reports, this report provides an interesting, and somewhat different, picture of QIHU's growth in the directory market.
On page 14, the report claims that based IResearch information, from January 2011 to October 2011, the monthly Unique Visitors of the directory sites in China increased slowly. It's still growing, but at greatly reduced rates than in the past. In addition, it claimed that hao.360.cn (QIHU's Personal Home Page and main source of income) grow in this period by only 2.9%. It is important to note, that the number of Chinese Internet users grow by 12% in 2011. So If the total Internet market grow only by 12% and the company on which investors (and QIHU) base their Due Diligence claims the number of users on QIHU's portal grow by only 2.9%, how do we reconcile the explosive growth in users and revenue the company claims?
No wonder QIHU stopped using the IResearch information in Q1 2011 on the growth of its Personal Home Page and kept quoting IResearch only for information relating to non-revenue generating products.
Furthermore, Citron has also provided information from Alexa as for QIHU's market share in the Chinese Internet market. As a response, QIHU claimed that Alexa is unable to count the user numbers of QIHU as they mostly use the company's own browser that prevents Alexa from gathering information. Let's assume this is true. We have prepared the following table, which presents information gathered through Alexa on some of the most popular Chinese websites and provides on the rank in China, the number of links linking to the website and the 10 largest sites where users came from to the website. Even if a significant part of the users of QIHU surf with the QIHU browser, some will probably surf with other browser that would be tracked by Alexa.
We believe the fact that only one of the 16 sites even mentioned QIHU's website as a source for traffic (and only at 10th place) provides more evidence that QIHU exaggerates its market share in the directory business. If they had such a dominant position as they claim, significantly more users using other browsers would have used QIHU's site to surf to these popular sites. If the company will counter-claim that other browser users don't use QIHU's website and only QIHU browser user do, its just a demonstration of the fact that their website is more like spam than a source for content and revenue.
Also, the company announced in May 2012 a buy back of $50 million, clearly to bust the share price. Since then the company did not report even a single share purchased.
We believe QIHU's revenues are overstated and therefore recommend selling short the stock.