Qihoo Resignations: Trouble Brewing?

| About: QIHOO 360 (QIHU)

Normally the sudden resignation of a quarter of a company’s board would ring alarm bells for many investors, but just the opposite seems to be the case for controversial software security specialist and rising online search star Qihoo 360 (NYSE:QIHU). The company’s shares jumped nearly 6 percent during the latest trading session in New York, and then managed to maintain most of those gains even after it announced the resignation of 2 of its 9 directors after the market closed. But that kind of performance seems normal for Qihoo these days, as investors buy heavily into the bullish growth story for its search business and ignore a number of potential warning signs, including these latest resignations.

Qihoo’s shares moved on a steady upward trajectory last year, more than tripling as the company’s recently launched So.com search engine made steady gains against dominant industry leader Baidu (NASDAQ:BIDU). Qihoo’s service had already gained more than a fifth of the market by the end of last year, and just last week the company bullishly proclaimed it was aiming for more than a third of the market by the end of 2014. All of this comes despite the fact that Qihoo has yet to make much money from its search business, though investors are hoping that will change soon.

Against that backdrop, the latest resignation of 2 of Qihoo’s 9 directors certainly looks a little strange. After all, why would directors want to leave this kind of red-hot company with such good future prospects? But then again, Qihoo is not your ordinary fast-climber, and its Chinese name that translates to “strange tiger” is perhaps quite appropriate here.

According to the latest company announcement, 2 directors, Hong Chuan Thor and Shujun Li, have both resigned for “personal reasons.” (company announcement) Both men come from private equity and investment advisory backgrounds, and the pair collectively represented one-third of the 6 independent directors on Qihoo’s board.

Interestingly, the names of both were still present on Qihoo’s website when the announcement came out, indicating that perhaps the resignations were sudden rather than a planned move. Also interestingly, Thor was chairman of Qihoo’s corporate governance committee, while Li was a member of its audit committee, possibly the chairman, based on the wording of the announcement. While Thor will leave immediately, Li’s resignation won’t become effective until after the company files its annual report on May 1.

I don’t know how other people might interpret this development, but to me it seems to have red flags all over it. The resignations seem to imply there was some kind of disagreement between these 2 directors about Qihoo’s financial statements and also its corporate governance, which is never a good sign. That’s especially relevant following a steady stream of short-seller reports and even an article in Forbes magazine over the last 2 years questioning the accuracy of Qihoo’s financial statements. To its credit, Qihoo has managed to defend itself after each attack and rather than falling, its shares keep climbing to new highs.

I’ve long said I suspect there’s at least some truth to some of the reports, since Qihoo is known for its aggressive business tactics in general. I’ve also said several times the company’s shares could be due for a correction, following their recent run-up that has made them quite expensive with a price-to-earnings ratio of more than 100. I still believe that such a correction is due, possibly later this year. But that said, I also suspect investors will probably just dismiss these latest board resignations the same way they have already ignored all the other warning signs about this strange company.

Bottom line: The sudden resignation of 2 of Qihoo’s independent directors hints at internal disagreement over the company’s finances, but is likely to be ignored as unimportant by bullish investors.

Disclosure: None

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