Sohu Cut to Neutral

We have downgraded Sohu.com Inc. (SOHU - Analyst Report) from Outperform to Neutral as the stock faces near-term risks due to delay in game launches, intense competition and concerns related to online ad spending.

Sohu is the third-largest internet portal and one of the most well-known online brands in China. However, its core business of brand advertising and online games faces fierce competition in China from big players like Shanda Interactive (SNDA - Snapshot Report), Baidu.com (BIDU - Snapshot Report), Netease (NTES - Analyst Report) and SINA (SINA - Analyst Report).

Earlier, the company had reported strong second-quarter results with both revenue and EPS beating the Zacks Consensus Estimate. Moreover, it provided better-than-expected third-quarter guidance. However, its performance is expected to be overshadowed the macroeconomic concerns facing China in 2009.

The company had spun-off part of its gaming division Changyou.com (CYOU) in an ADS offering. While this unit is expected to boost user base and market share in the multi-player online role-playing game space, the IPO will also dilute near-term EPS.

However, we remain encouraged by Sohu’s growing cash balance and debt-free balance sheet. We expect the company to drive meaningful growth through strong fundamentals in 2010.

The recent delay in launching online games by Changyou has increased uncertainty regarding its future plans. However, we still believe that it is important for Changyou to create a quality product rather than hastily launching new games that could jeopardize its reputation.

But in the meantime, competition and the successful launch of new games by its competitors would definitely eat into Sohu’s market share. We have thus cut our six-month outlook on the stock to neutral.