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Sohu.com (SOHU - Analyst Report) recently announced that its subsidiary Changyou.com (CYOU - Snapshot Report) has entered into an investment agreement with Kalends Inc. to acquire a 62.5% equity interest in the latter’s free social communication platform Raidcall for $50.0 million in cash.

The Raidcall application allows user groups to communicate online on a real-time basis. This means that groups while playing online games or listening to music can chat, text or record their activities on video.

The software has a user base of almost 20 million and is available in 14 different languages. We note that professional gaming teams such as Fnatic and Evil Geniuses are registered users of Raidcall. Sohu expects to close the acquisition in Dec 2013.

The acquisition of the stake in Raidcall reflects Changyou’s focus on building a global gaming platform, which will offer end-to-end communication among gamers on a real time basis. We believe that the availability of the software will help in driving Changyou’s user base going forward.

Lately, gaming has been one of the key growth catalysts for Sohu. In the recently concluded third quarter of 2013, online games revenues increased 7.5% year over year to $161.5 million. For the upcoming fourth quarter, online game revenues are expected in the $171.0 million–$176.0 million range.

Besides gaming, mobile video and search (Sogou) are the other key growth drivers over the long term. We believe that the recent partnership with Tencent will improve Sogou’s competitive position against market leader Baidu Inc. (BIDU - Snapshot Report) and Qihoo 360 Technologies (QIHU - Snapshot Report), which ranks second in both PC and mobile search market going forward.

Additionally, the partnership with Tencent will boost Sogou’s traffic, which will further drive Sohu’s top-line growth going forward.

However, Sohu is a relatively small player in the online advertising market and continuing investments in product development are necessary to expand market share. This will keep margins under pressure in the near term. Despite higher spending, we believe that market share gain will be difficult in the near term due to stiff competition in most of its operating markets.

Currently, Sohu has a Zacks Rank #4 (Sell).

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