The People’s Republic of China, the world’s second largest economy, is experiencing a surge in internet use as the expanding middle-class increasingly gets access to this technology. While internet use is heavily regulated in China, with the government’s Great Firewall used as a means to shield the consumer from politically sensitive information or anything else the government deems undesirable, a number of very profitable companies have managed to stake out a place in the system. While the Chinese internet space is becoming more crowded, a few names still stand out. In this article I will briefly examine the prospects of Qihoo 360 Technology Co Ltd (NYSE:QIHU).
Stock Overview
Qihoo operates mainly as an internet security company, offering anti-virus solutions, firewalls, mobile security, and a browser. Additionally, the company offers advertising and cloud services, as well as a newly introduced search engine. The company recently had some negative publicity for unfair competition involving a Microsoft Corporation (NASDAQ:MSFT) patch, for which it received a warning letter from the Chinese government. Coincidentally, Microsoft recently got hit by an antitrust suit of its own in the EU totaling about $731 million. Microsoft competes with Qihoo mainly in the browser division, in which it holds nearly 50% of the market share, although this number on the decline. Qihoo stock, which has a market cap of $3.84 billion, is fairly volatile with a beta of 2.34, and does not offer a dividend. What it does offer on the other hand is impressive earnings potential, as well as a clean balance sheet.
Earnings and Balance Sheet
Qihoo released their most recent report on Tuesday after hours, soundly beating analyst expectations. The reported EPS of $0.22 beat by five cents, and revenue was also impressive coming in at $103 million. This represents a huge 65% YoY increase, and was $9.32 million above the consensus. Advertising revenue growth was stronger than expected with a 49% increase compared to the same period a year ago. The non-GAAP operating margin was down fairly dramatically compared to Q4 2011, but according to management this was expected due to the expansion of their development team and investments in support service infrastructure. For the full-year, revenue was up an astounding 96%.
Looking forward to Q1 2013, the company is expecting revenues between $104.5 million and $106.5 million, well above the analyst consensus of $92.7 million, representing an increase of 51-54%. Analysts expect EPS of $1.00 in 2013, which is a 25% increase compared to the 2012 full-year figure. Aside from these excellent earnings, the company has a healthy balance sheet. For the quarter, the company held cash and cash-equivalents totaling $380.7 million, and cash from operating activities of $53.1 million. Furthermore, the company has zero debt on the books.
Redesigned Search Engine Model
Some of the company’s recent revenue growth is being generated by its redesigned search engine model, a division which is of course meant to compete with China’s number one search provider and internet titan, Baidu.com, Inc. (ADR) (NASDAQ:BIDU). Baidu holds over 70% of the search engine market share in China, and like Qihoo, is growing revenue very rapidly. Qihoo’s management has claimed to now hold a double-digit market share in the search engine arena, which had some investors worried about Baidu.com, Inc. (ADR) (NASDAQ:BIDU)’s ability to hold its dominant market position. However, some commentators doubt whether or not this is a fair reflection of the current standings, as it does not take into account the share that the company previously had in indirect searches. Still, the search segment seems to be doing alright.
Valuations and Metrics
By most people’s standards, Qihoo isn’t cheap at the moment. However, this seems to be the price the market is willing to pay for such formidable revenue growth. The stock currently trades at about 80x TTM earnings, which is well above the industry average. The price to book is also pretty high at 10.60. For comparison, US competitor Microsoft Corporation (NASDAQ:MSFT) trades at 15.45x TTM earnings and only 3.24 to book. Of course, Microsoft isn’t delivering nearly the same kind of top line growth that Qihoo is reporting. Qihoo has a TTM operating margin of around 15% and return on equity of about 11%.
Bottom Line
Qihoo is delivering absolutely staggering revenue growth at the moment, propelled by soaring ad revenues and a strong position in the Chinese mobile market. On the other hand, the company isn’t exactly a shining example of ethical business practice. The outlook for 2013 remains impressive, and the company should be able to continue this strong growth looking ahead at Q1 2013. I am slightly skeptical about the high multiples at which the stock is currently trading, but such multiples aren’t unheard of for high-growth internet companies. After a good run in the last year, the stock may have more upside in the coming months.
The article This Chinese Internet Company Is Setting Up for Big Earnings originally appeared on Fool.com and is written by Daniel James.
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