Earnings Preview

| About: Inc. (SOHU)
This article is now exclusive for PRO subscribers. Inc. (NASDAQ:SOHU) is set to report its fourth quarter and full-year 2011 results on February 6, 2012, before the market opens. Sohu reported a mixed third quarter, as the company missed the Zacks Consensus estimates by a penny, despite beating revenues handily.

Sohu’s third quarter earnings increased 15.8% year over year to $1.17 per share (including stock-based compensation) based on a 42.0% total revenue growth in the quarter. Despite the mixed results, Sohu provided an upbeat fourth quarter guidance and forecasted total revenue to be in the range of $241.0 million to $246.0 million.

Sohu expects EPS in the range of $1.30 to $1.35. For further details please see Sohu Misses on Higher Expenses.

Estimate Revision Trend

Currently, the Zacks Consensus Estimate for the fourth quarter is pegged at $1.23, up 15.0% from $1.07 reported in the year-ago quarter. This is based on an estimated revenue growth of 40.5% year over year to $243.0 million.

In the last 30 days, none of the nine analysts covering the stock revised their estimates for the fourth quarter. We note that Sohu has posted an average earnings surprise of 4.90% in the trailing four quarters, implying that it has outdone the Zacks Consensus Estimate by the same magnitude for the last four quarters. We don’t expect a major change in the earnings trend pattern for the current quarter.

Our Recommendation

According to a latest report from China Internet Network Information Center (CNNIC), the number of Internet surfers in China reached approximately 513.1 million at the end of calendar year 2011. Strong user growth was noticed in the search and online video market over the last twelve months. This trend bodes well for Sohu going forward, as the company continues to increase its investments in search and online video.

As per the latest data from market research firm Analysys International, Sohu Video had 13.3% of China's online video market at the end of fourth quarter of calendar 2011; lagging #2 placed Tudou Holdings Ltd. (NASDAQ:TUDO) by just 40 basis points. We believe that ongoing content additions (domestic, as well as American television dramas) will boost Sohu’s online video market share going forward.

In the third quarter, Sohu entered into a partnership with MSN China to build an exclusive online video platform for MSN, solely operated by Sohu video. Management believes this to be an exciting opportunity for Sohu as it will increase its traffic and monetization growth due to the comparative affluence of the MSN users. We believe that the partnership will help Sohu to faster penetrate the online video market in the near term.

Sogou continues to gain market share due to the popularity of its browser, which drove maximum traffic on the search engine in the recent past. We believe that Sogou is also benefiting from the pre-mature withdrawal of Google Inc. (NASDAQ:GOOG) from China as erstwhile Google users are now shifting to Sogou rather than to Baidu Inc. (NASDAQ:BIDU).This is expected to further boost Sohu’s market share going forward.

Sohu is also expected to benefit from its strength in online games. We believe that Sohu’s promising games portfolio and the growing popularity of Changyou’s games will drive profitability over the long term. Sohu has a solid game pipeline including Battlefield Online and a couple of massively multiplayer online games (MMO) which will further boost its top-line growth going forward.

However, higher operating costs due to continued investments in video may hurt profitability in the near term. Moreover, cut-throat competition and increasing government scrutiny into Chinese Internet usage may also hurt Sohu’s growth over the long term. We, therefore, maintain our Neutral recommendation on the stock over the long term.

We note that the stock has appreciated approximately 18.0% over the last one month compared to a 3.8% increase in the S&P 500. Considering Sohu’s growth opportunities in the near term, we believe that the shares are undervalued. Currently, Sohu has a Zacks #1 Rank, which implies a short-term Strong Buy rating.

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