IBD 50 Stock Qihoo Vies With China Web Search Rivals

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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 ( QIHU ), 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 ( BIDU ), 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 mobile space.

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 's ( MSFT ) 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 Maxim Group.

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 ( SOHU ) .

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 coverage.

"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 ( GOOG ) 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 really big."

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."



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: BIDU , GOOG , MSFT , QIHU , SOHU

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