In today's fast-evolving Internet age, it's no easy task for
investors to find promising companies still in an early stage of
the business cycle.
Qihoo 360 Technology (
), the Chinese Internet company, may fit the bill. It's No. 31 on
the IBD 50 list of top-ranked stocks.
The maker of browser and security software and mobile apps
began a search engine business in August 2012. By August this
year, its market share in that area hit 18%, and in October 21%,
according to data tracker CNZZ. Qihoo is the second-largest
search engine provider in China afterBaidu (
), which has a penetration rate near 63% in that market.
So far, search hasn't contributed a significant portion to
Qihoo's revenue. And there is still a lot of growth ahead in the
Qihoo owns most of the sources for its search traffic. It gets
traffic mostly via its "360"-branded browser, start page, search,
anti-virus and security platform as well as its mobile apps. At
the end of last quarter, its browser had 330 million monthly
active users. Its personal start page and subpages had 114
million average daily unique visitors.
Battle Of The Browsers
The company aims to increase its search market share to 30% in
2014. Its browser is the second-largest in China, behindMicrosoft
) Internet Explorer, and should provide additional search
traffic. Credit Suisse analyst Dick Wei expects the search
revenue to grow at a 63% average annual rate to $317 million, or
20% of the firm's total revenue, by 2015.
The growth is expected to come from an expanded sales force,
better back-end systems, and enhancement of the user search
experience via better algorithms. Wei estimates that this could
take about two years.
As Qihoo maintains its ability to grow traffic share, this
will lead to increased search revenue, says analyst Echo He of
Search "obviously is a large market anywhere, including
China," He said. And Qihoo's revenue growth is "probably going to
be higher than the sector average."
Qihoo's stock price is up nearly 200% this year. However it
took a beating, starting in September, after China's e-commerce
firm Tencent Holdings paid $448 million for 36.5% of Web search
engine Sogou, which is owned bySohu.com (
With Sogou the third-largest search engine in China, analysts
had long viewed the firm as a potential buyout opportunity for
Qihoo. So this deal surprised investors.
Nevertheless, analyst He believes losing out on this deal will
not likely change the course of Qihoo's search growth. Sogou's
traffic share, which He estimates at 8% to 10%, may not be as
large as perceived and may have overlaps with Qihoo's. Also,
integrating a merger may be challenging and could lead to a
significant share dilution for current shareholders, He writes in
a research report.
Qihoo started as a provider of free Internet security
software. Today it is the largest security products provider in
China for both the PC and mobile markets. It had 461 million
monthly active users on the PC platform at the end of June,
equivalent to a user penetration rate of 96%. Mobile active
security users stood at 338 million.
This strong position in the Internet security business has
allowed Qihoo to rapidly gain market share in search, thanks to
existing customers who started using its platform. But as
mentioned, monetization has been slow and there is ample
opportunity in the mobile market to expand its browser
"We consider Qihoo as a proxy for investors looking for
exposure to China's mobile Internet usage penetration story,"
wrote Wei. "Qihoo is one of the few companies owning powerful
monetization channels on mobile, in the early ramp-up stage of
China's mobile Internet growth.
Ad revenue coming from various PC and mobile platforms
accounts for about 60% of Qihoo's total revenue. Its
second-largest revenue generator is online games, accounting for
32% of the total, He estimates.
Qihoo has the largest Android app store in China, for users of
mobile phones and other devices that run onGoogle 's (
) Android operating system. Third-party app stores are dominant
in China's mobile market. Qihoo distributes 50 million apps and
games daily. It gets a revenue share from game makers when mobile
users download their apps.
"Mobile is booming in China, so they will benefit a lot from
the demand from the enterprise side to build their mobile apps,
as well as benefit from the user side, to use mobile more," said
Tian Hou, an analyst at T.H. Capital Research. "Mobile could be
Wei expects mobile to grow at a 70% average rate by 2015.
Mobile ads account for about 5% of Qihoo's total revenue now, and
is expected to expand to 10% by the end of 2014.
Investing In The Business
Analysts expect margins to slip in the short term, as Qihoo
builds out its platform. It is mostly due to more research and
development, as well as marketing, and growing the sales force.
The decline is not expected to be permanent and margins should
pick up in the longer term.
As with any fast-expanding firm, there are risks. One is not
growing traffic as fast as expected, due to rivals or other
factors. And if China's economy were to slow, search spending by
enterprises could drop.
Still, management has a strong track record and has been fast
at bringing new products to market.
"They have a pretty strong execution capability," He said. "If
they can grow search into a bigger operation ... revenue should
not be a big problem. If they continue to grow traffic, then
upside seems higher than a lot of Internet peers."