Sohu: Forgotten But Value Remains

| About: Inc. (SOHU)


Investor interest in SOHU is waning given the weak core growth, margin pressure and competitive outlook.

Decelerating search and higher content spend will be two overhangs for the stock sentiment in the near term.

Digital properties have value to the Chinese telcos as they increasingly look to bundle digital content and wireless.

Does the Street even care about Sohu (NASDAQ:SOHU) nowadays? The short answer is no. The company has failed to evolve over the years despite seeing positive momentum in video and search but poor execution led to its current state of decay. Q2 results underscores my view with revenue of $420m and EPS of -$1.64 both came below consensus, and guidance of $400m-$430m also missed consensus expectations.

The increasing investment in original video content has been costly for SOHU but the management appears to be determined to sticking to this course in the foreseeable future. With the portal business in a state of perpetual decline, the video business unable to compete against the scaled players, a decelerating search business due to competition/market maturity/regulation and a gaming unit that is losing traction, SOHU is really between a rock and a hard place.

The good news is that even with all the bad news, SOHU continues to have some value given its digital footprint. For any buyer that has sufficient financial resources to compete against the big 3, namely Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU) and Tencent, then SOHU could be a valuable asset. If Verizon's (NYSE:VZ) acquisition of AOL and Yahoo's core business is any indication, portals such as SOHU continue to have value. In the near term, I would remain cautious on the stock, but for short sellers, it is equally important to note that the M&A theme will provide some support to the stock price.

Two risks to SOHU's operating profile will be in its content spending and deceleration of search. SOHU has been ramping up on original content with 20 dramas planned this year. So far, the company has delivered 7 dramas, so investors can expect another 13 in the second half, which is likely to weigh in on margins. In addition to content spend, marketing expense associated with the video content will increase as well, further pressuring margins.

The other risk is the search portal that is facing a combination of competitive pressure and regulatory risk. Similar to the challenges faced by Baidu (see - Baidu: Time To Punch Out), SOHU is also susceptible to the regulatory overhang on healthcare advertising on search pages, but given that Sogou is also a smaller player in online search, industry leader BIDU will increasingly look to take shares away from Sogou given that BIDU's organic growth profile appears to be in stagnation if not outright decline.

The bright side to this story is that Sohu, along with rival portal Sina (NASDAQ:SINA) still have some value to companies that are looking to go into digital media and content. Chinese telecom companies such as China Mobile (NYSE:CHL), China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA) all face the threat of mobile broadband in which apps such as WeChat are replacing traditional telecom services such as voice and SMS.

To make up for the shortfall in these two segments, the telcos can bundle digital content and properties with their telecom services to drive higher data usage. This is essentially what VZ is looking to do and I don't see how the Chinese telcos will be any different given the maturing industry.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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