With the coming IPO of China's largest e-commerce portal, Alibaba, investors are looking for more ways to play the massive growth of the world's largest common-language/culture Internet market. Alibaba, who is still owned 24% by Yahoo (YHOO - Analyst Report), has astonished web-focused investors with its consistent profit growth and massive revenue haul.
Alibaba's fourth quarter saw a huge quarterly profit gain -- its fourth straight -- of $792 million on sales that surged 51% to $1.78 billion. Word is that Alibaba's transaction volume is greater than Amazon (AMZN - Analyst Report) and eBay combined.
Until the IPO of the "Amazon of China," which is projected to be valued at as much as $200 billion, I am buying a young upstart in the Chinese web jungle: Qihoo 360 Technology , the country's largest Internet security provider, with over 460 million monthly active users, representing a penetration rate of 96% in the biggest web market.
I first wrote about QIHU last September when I saw them taking the #2 spot in search next to the giant Baidu (BIDU - Snapshot Report)...
The Story is Out
Qihoo 360 Technology offers a broad spectrum of Internet and mobile security products. Its core Internet and mobile security products include 360 Safe Guard and 360 Anti-virus 360 Mobile Safe, 360 Safe Browser, 360 Personal Start-up Page, 360 Application Store and 360 Safebox.
In a brilliant strategy move, Qihoo 360 began offering its cloud-based Internet security products for free to users. And this has allowed them to monetize their significant audience through online advertising services, including paid links as well as Internet value-added services, such as offering access to third-party Web games and virtual items.
In 2013, the company's launch of a search engine so.com was the game-changer that leveraged its broad reach in China to capture lucrative search market share and advertising dollars. The 360 brand stands for Internet security to the company's users, and these users are a ripe audience for advertisers.
But the innovation didn't stop there. In September, the company launched 360 Yingshi Daquan, the mobile version of 360 Video, Qihoos video vertical search engine. 360 Yingshi Daquan is a 360 mobile app that enables users to search for and view videos from Qihoo partners on Android based smartphones.
What else do Chinese PC and mobile users rely on Qihoo 360 for? Gaming! In an early June research report after meeting with QIHU management, Jefferies analysts noted...
Qihoo has "robust web game growth with strong mobile game player acquisition. Management continues to see a 40%+ organic revenue growth and stable ARPU trend on web games with the majority of the incremental paying gaming accounts attributed to mobile games. The small acquisition of several game companies in early 1Q14 was done to improve Qihoos game platform monetization despite their low-margin business profile." Jefferies has a $150 price target on Qihoo shares.
As Facebook (FB - Analyst Report) seems to be hitting its stride with mobile ad revenues, many analysts believe bigger success is around the corners for QIHU as well. Here's what Macquarie had to say in late January...
We believe Qihoo is seeing solid trends across all its major business lines directory page ads, mobile app store, search and web gaming. Qihoo remains one of the few platform companies in China that control the bulk of the Internet and mobile Internet traffic, thus future monetization opportunities from the traffic.
Controlling "the bulk" of Internet and mobile traffic sounds like a pretty good position to be in.
According to Bloomberg, "Alibaba is competing with Tencent Holdings and Baidu for Chinas 618 million Internet users by making deals in its home market and the U.S. to extend its e-commerce reach to mobile games and messaging."
The growth rates sound like theyre pretty positive for the entire sector, for e-commerce. They have a large base, they have the lions share of e-commerce in China, said Stephen Yang, a Hong Kong-based analyst at Sun Hung Kai Financial Ltd. For Alibaba itself, how many large cap companies this size are going to get 51 percent growth?
That is impressive. And it should come as no surprise that the smaller, more nimble Qihoo is growing at high double digits as well, with projected 140% EPS growth in 2014 and 70% growth for next year. So the question becomes "Can Qihoo keep it up and compete for market share in these areas against the giants?"
Macquarie analysts believe the Qihoo App Store is currently the biggest story at Qihoo with its app store having 30% market share in terms of time spent, according to iResearch.
They note, "with the proliferation of apps and mobile games in China and ongoing consolidation of the app distribution channel (e.g. app stores), the balance of power is shifting to the app store side from the developers. We don't believe the recent announcement by Alibaba to take only 20-30% of revenue share compared to the industry norm of 40-50% today will change the industry dynamics as Alibaba does not have critical mass yet in terms of the app store traffic."
The Search Question
With a forward P/E multiple now below 30X due to strong quarter-after-quarter of growth, QIHU shares have seen quite a bit of volatility in the past few months as investors and analysts weigh how much of the search market they have. The drop from $120 to $90 has made the risk/reward much more attractive, trading 25% above Baidu's valuation but with double the growth rate.
The company claims over 20% market share of search, but some critics say it's probably lower and so not likely on a path to achieving expectations of 30% share that the company projects is possible by the end of this year.
But the Macquarie analysts don't see that as the big issue right now. They figure it's a wide, yet growing, range of 15-25% search share right now and leave it at that. Why so sanguine about this key metric?
Because they see Qihoo growing revenue share splits on search from the current 2% to as high as 10%, "especially when it is launching a new keyword bidding system in mid 2014." And this month brought the launch of Qihoo's new mobile search engine.
All in all, the pace of innovation to serve more web users is keeping Qihoo revenues growing at quite a clip. Jefferies analysts project 2014's top line to hit $1.3 billion, 2015 to threaten the $2 billion level, and 2016 to reach $2.7 billion. Here's a look at that top-line growth trajectory which is growing faster than Baidu's current $5.8 billion haul...
Bottom line: Qihoo has quickly become a major player in the Chinese web ecosystem because they entrenched themselves as the reliable must-have security provider. Now they just have to keep the bad guys down, the traffic humming, and the innovations rolling to keep growing at high double digits.
Disclosure: I own Qihoo 360 shares for the Zacks Follow the Money portfolio.
Kevin Cook is a Senior Stock Strategist for Zacks where he runs the Follow The Money portfolio.