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The following is a short update on the previous article we wrote about Qihoo 360 (QIHU) in June 2012. The company's Q2 2012 press release and conference call provides further evidence that the company is providing verification of its operating metrics only for its free products and does not provide such verification for the income generating products. The free products of the company include the web browser and desktop and mobile security software. Income generating revenues are the company's home page (through ads and search referrals) and web games. The company usually quotes IResearch as their favorite market share research firm.

QIHU reported for its second quarter an increase in revenues of 5% over its Q1 2012 revenues and a net income of $7 million, which was down 50% from the first quarter. Even if we would trust management's numbers, the current valuation of approx. $3 billion provides for a PE ratio of 100 (based on the first half of 2012). Just for a reality check, Focus Media's (FMCN) management has recently offered to take the company private at a multiple of 15.

In our previous article we provided some evidence that while management highlights that the company's operating metrics are based on third party research (of IResearch), this information is provided only for the free products. When it comes to measuring the operating metrics of the revenue producing products such as unique visitors, clicks or web game players, QIHU does not provide the disclosure that a third party has verified these operating metrics. In Q2 the company continued with the same approach and did not mention any third party verification of revenue generating operating metrics.

In the Q2 conference call, the Chairman of QIHU made the following comments about the free products:

As I mentioned earlier, active users of our PC-based products and service reached 425 million in June according to data from iResearch, and our user base represents 94% of the channel active PC Internet users.

According to data from iResearch and CCID, total smartphone user of Qihoo 360's mobile security solution already reached 120 million, representing almost 70% of the market share in the smartphone mobile security.

Later on the call, the CFO reminded listeners that the figures he just mentioned for the free browser usage are backed by IResearch:

Monthly active users for Qihoo 360 browsers were 272 million compared with 209 million a year-ago and 273 million in the prior quarter. Qihoo 360's browsers' user penetration rate was 61% compared with 52% a year-ago and 62% in the prior quarter. I would like to remind everyone that above user statistics of our products are based on data from iResearch.

In his next sentence, QIHU's CFO was referring to the services which do generate revenues (start-up page and web game), without mentioning the verification by IResearch:

Average daily unique visitors to 360 Personal Start-up Page and its sub-pages in the second quarter were 83 million compared with 42 million a year ago and 77 million in the prior quarter. Average daily clicks on 360 Personal Start-up Page and its sub-pages in the second quarter were 368 million, compared with 124 million a year ago and 295 million in the prior quarter. As of June 30, 2012, we had a total of 98 games commercially running on our web game open platform. Total web game paying users reached 148,000 in June. Web game gross ARPU for this quarter was approximately RMB400.

Further evidence is found in the footnotes No. 3 to the press release filed with the SEC. Only the free products have been verified by IResearch. That leaves investors with the only option available to them- trust management with the operating metrics of the income generating products.

There is no third party verification for unique visitors (affecting the ad rate the company can charge for ads on its site), clicks on its home page (click based income) or web games players (apparently 148,000 people are paying an average of RMB400 per month or $62 to play on QIHU's sites!).

Last but not least, the company announced on January 5th a plan to repurchase up to $50 million of its shares. Up to now, the company did not report the acquisition of even a single share which suggests this announcement was merely a PR stunt to increase the share price of QIHU.

To conclude this article, based on:

  • the current valuation implying a PE ratio of 100
  • the risk from the (continuing) lack of transparency into the actual revenues generating operating metrics of the company
  • the risk to investors from the discrepancies between the market share data published by the company and the IResearch report we highlighted in our previous article, which claims QIHU's growth rate in the directory market is significantly lower than the growth rates the company is claiming
  • the company's PR share acquisition stunt

we believe QIHU's share price is significantly overvalued and does not price the risks we highlighted. We therefore recommend to short the stock.

Source: Qihoo Q2 Update: Absurd Valuation With No Transparency Into Revenues