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On Jul 4, 2013, Zacks Investment Research downgraded (SOHU - Analyst Report) to a Zacks Rank #5 (Strong Sell).

Why the Downgrade?

Sohu reported earnings of 60 cents per share that comfortably surpassed the Zacks Consensus Estimate by 4 cents. Revenues jumped 35.7% year over year and 2.7% sequentially to $307.6 million, ahead of the Zacks Consensus Estimate of $290.0 million.    

Although Sohu reported an impressive first quarter, escalating costs remain a major headwind going forward. Operating expenses, as a percentage of revenues, were 43.3% compared with 41.9% in the year-ago quarter.

The sharp year-over-year rise in operating expense was primarily due to higher sales & marketing expenses, which as a percentage of revenues jumped 200 basis points (bps) to 19.1% in the reported quarter.

Sohu is a relatively small player in most of the markets it operates in. Hence continuing investments in product development and sales and marketing are necessary to expand market share as well as fight competition. This will keep margins under pressure going forward.

Moreover, higher stock compensation expense ($2.0 to $3.0 million) is expected to reduce earnings by 5 to 7 cents in the second quarter.

The Zacks Consensus Estimate for the second quarter of 2013 has declined 9.3% (5 cents) to 49 cents over the last 30 days.

The Zacks Consensus Estimate for 2013 decreased 2.6% (7 cents) to $2.58 per share over the last 60 days. The Zacks Consensus Estimate for 2014 dropped 5.9% (23 cents) to $3.69 per share over the same period.

Other Stocks to Consider

Not all Internet service providers are performing as poorly as We recommend Akamai Technologies (AKAM - Analyst Report) and Yahoo! (YHOO - Analyst Report), both with a Zacks Rank #1 (Strong Buy). Facebook (FB - Analyst Report), a Zacks Rank #2 (Buy) stock, is also looking good at present.

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