The search engine market is always so tempting. Whoever controls the "entrance" of the Internet controls the gate to making products popular in a short time. Tencent (OTCPK:TCEHY), as one of the dominant Chinese Internet companies, didn't have a search engine of its own before they injected money into Sogou.com, which is controlled by Sohu (NASDAQ:SOHU). After the deal, Tencent owns the third largest search engine company that could have outstanding synergy with Tencent's instant messaging app - Wechat.
It's still early to judge whether the Wechat & Sogou marriage will have a happy ending. Theoretically, it's a win-win deal. Sogou needs more traffic; Wechat needs a search engine to transfer more PC volume to the cellphone end, and vice versa. Wechat's information and data were isolated within its own ecological system before the Sogou deal. Sogou also owns Sougou Pinyin, which is one of the most popular input tools in China. Note that, after the Tencent deal, Tencent's QQ browser's default search engine has been changed to Sogou. This is a hint that Tencent has merged whatever they have to Sogou as the deal was eager to make a sound in the search engine market.
What I'm interested in is the valuation of SOHU behind the Sogou deal. Now, let's look at the deal in details.
Tencent purchased 36.5 percent of Sogou for $448 million USD in 2013. According to rumors, Tencent has increased its shares in Sogou to 40 percent.
$448 Million/0.365= $1.227 billion USD. Alibaba owned 10% of Sogou before Souhu purchased the shares back for 25.80 million dollars. Souhu still controls Sogou as the biggest shareholder.
SOHU's stock price has not been doing well since March this year. As I am writing this article, SOHU is about $56 a share with a market cap 2.16 billion dollars.
Sogou is worth more than 1.2 billion dollars and SOHU owns more than 50% of it. To get a valuation without Sogou, we use 2.16 (market cap) - 0.6 (shares of Sogou) = 1.56 billion dollars. SOHU has more than 1 billion cash or cash equivalent, long-term debt is no more than 257 million dollars. Now I use 1.56 - 1 (cash or cash equivalent) + 0.257 (debt) = 0.817 billion dollars. The real market cap is 817 million dollars.
Of course, as the major income provider of SOHU, subsidiary Changyou (NASDAQ:CYOU) is not pumping cash to SOHU this year due to some strategic errors. We simply don't talk about this as the issue isn't the idea of this article. CYOU will expect to turn next year, as the expense from investing in mobile games will come down dramatically.
SOHU's valuable assets like TV.SOHU.COM, SOHU FOCUS, and along with advertisement departments are selling at 817 million dollars.
TV.SOHU.COM is famous for its exclusive American TV dramas, which has established a large number of stable viewers. SOHU is splashing cash to buy exclusive shows for its online video platform and I think investors should be a little bit patient until the investment pays off. According to Youku Tudou (NYSE:YOKU), SOHU TV owned about 10% of the Chinese online video market in 2012. It has gained more ground since two years ago, and I think it's not that far away from YOKU. YOKU's market cap is around 3.57 billion dollars; SOHU TV on the other hand, shouldn't be lower than 1 billion dollars. With a market cap around 2.16 billion dollars, SOHU TV, as a rapid growth department, is priced way under its true value.
The online streaming video market is the one market where merging makes perfect sense. Besides, SOHU FOCUS is one of the best domestic real estate websites. It is an asset that they can spin off for much higher valuation. All I'm saying is, SOHU has a few departments that are undervalued. The numbers simply don't make sense even with Sogou's old evaluation.
The numbers don't add up when I do a comparison with similar public companies out there. Conservatively speaking, I think SOHU has been undervalued by at least 30% to 40%, which indicates a target price at about $80 a share.
The problem is obvious. SOHU needs to invest a lot of money into its online streaming business. And, we have no idea when the profit will come. Good news is that SOHU has enough cash to burn for quite a while. Sogou is already a winner and SOHU TV is a hidden gem.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.