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Welcome Rebound For Search Engine Company Qihoo

Published 11/26/2014, 04:00 AM
Updated 03/19/2019, 04:00 AM

Chinese search engine Qihoo 360 released its third quarter earnings on Monday evening, which beat both internal and analysts’ expectations. There was a favourable reaction from Wall Street to the results and conference call, and Qihoo closed on Tuesday up 7.6% to $74.74. Here are the four key points from the earnings and conference call.

The integration of MediaV

The big acquisition made by Qihoo in the second quarter was digital advertising firm MediaV, which will be used to improve the monetization of Qihoo’s PC and mobile search services. It was integrated into the Qihoo system at the end of September, so its impact won’t be seen until the fourth quarter. Nevertheless, Qihoo released a few new commercial tools in order to improve traffic monetization, including the 360 Juxiao advertisement agency, which will help users to better utilize their ad inventory.

China's Qihoo snapped up digital advertising firm MediaV in the second quarter, which should help it generate a revenue stream from its mobile and PC search traffic. Photo: Thinkstock

One issue that Qihoo has is that it has been slow to monetize its search traffic on both PC and mobile. This is because CEO and co-founder Zhou Hongyi believes that it’s more important to build a large user base, and from there monetization can be figured out. He has cited several rivals who have monetized searching too quickly, and their services have suffered and users subsequently departed.

As novel as this approach is, I get the impression that it’s becoming a bit of a burden for the firm, and that the rate of monetization has to improve over the next few quarters. Mobile search is yet to be monetized at all, despite the company’s switch to make mobile its core strategy, and hopefully the acquisition of MediaV will improve advertising revenues on both PC and mobile.

However, with management making this a priority, other projects have been put to one side, such as the Search Union project, simply because the firm already has a large user base that is undermonetized, so increasing the user base is inefficient.

Falling margins concerns

One of the causes of the heavy fall in equity valuation after the second quarter earnings release was falling profit margins, and it is somewhat evident again in the third quarter. Gross margin was 77%, compared to 86% a year ago and 79% last quarter, whilst non-GAAP operating margin was 24.8% compared to 35.5% a year ago and 21.8% in the previous quarter. The non-GAAP net margin was 23.8% compared to 32.7% a year ago and 21.8% last quarter.

The fall in sequential gross margin was due to a cost reallocation and a stronger focus on monetizing search. This is associated with the firm focusing its efforts on improving mobile search traffic, and it should provide notable improvements to revenues in the coming quarters. The fourth quarter should be key for investors to see progress in margins, because the investments in mobile and monetization will have begun to pay dividends.

Gaming trends

Qihoo’s biggest rival in PC and mobile gaming distribution is Tencent, but the two differ because Tencent tends to produce its own games, whereas Qihoo is a third party distribution platform via its market leading 360 Mobile Assistant app.

Tencent is increasingly bringing third party game developers onto its platform, and this has the potential to affect Qihoo, particularly as many of these third party games are exclusive to Tencent. However, most of these exclusive third party games are launched on Tencent’s WeChat, so these aren’t really a direct threat to Qihoo’s platform.

In addition, if games are exclusive to one platform, then the distributor will heavily market that particular game in order to recoup the cost of the exclusivity deal, and in turn this squeezes other games out of the market. Qihoo’s platform is different because the company rarely signs exclusivity deals with game developers, and when it does, it’s usual for a specific time period. This type of platform is better for developers as a whole, because their games won’t suffer due to exclusive games.

The firm is also seeing increasing competition for its 360 Mobile Assistant app, and rivals are increasing their market share. Qihoo’s management is currently not concerned by this, because while rivals are spending lots of money on building market share, they are taking this from smaller rivals as opposed to Qihoo.

Enterprise security

In the second quarter conference call, management discussed the big opportunities in enterprise security, and investors have been keen to see the progress that is being made.

During 2014, the firm has been making acquisitions, with a gaming company in the first quarter, digital advertising firm MediaV in the second quarter, and during the third quarter, several small acquisitions were made in order to strengthen the enterprise security team.

At the end of the fourth quarter, two new products will be released, with a few more being released in the early stages of 2015. So while progress is evidently being made, investors will likely have to wait until the fourth quarter conference call to see first signs of how the products are performing.

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