Sohu Downgraded to Underperform

We are downgrading Sohu.com Inc. (SOHU) to Underperform from our pervious Neutral rating and reducing our six-month price target to $45, approximately 10.3x 2010 earnings, a discount to the industry average. We expect the stock to continue trading at a discount.
 
While the company’s third-quarter earnings beat the Zacks Consensus Estimate and was in line with its own guidance, the outlook for the fourth quarter was well below analysts’ expectations.
 
Sohu’s operating expenses have been going up steadily, which we fear could limit the growth in earnings. Moreover, recent delay in game launches and weak ad spending is hurting the brand advertising revenue.
 
Strength in the company’s online games and portal business is encouraging and is expected to be the strongest driver of growth beyond 2010. Sohu has grown its revenue base from $80.4 million in 2003 to $429.1 million in 2008, a CAGR of 39.8%.
 
Net income on a non-GAAP basis was $40.9 million or 96 cents per share in the most recent quarter versus $42.8 million or $1.08 per share last year. This was at the high-end of the company’s guidance of 92 cents to 97 cents per share. The company’s quarterly revenues stood at $136.6 million, up 13.2% from $120.7 million in the year-ago period. Revenues were mainly driven by a 25.8% increase in online gaming revenues to $68.7 million.
 
However, the disappointing guidance for the fourth quarter and slow growth in earnings and revenues validates that Sohu is no more a growth stock. With weak ad spending, we are becoming more concerned about the company’s ability to grow in 2009 and 2010.
 
In the meantime, competition in its brand advertising and online games (Sohu’s core business) in China is fierce, crowded by big players such as Shanda Interactive (SNDA), Baidu, Inc. (BIDU), Netease (NTES) and SINA (SINA). Moreover the successful launch of new games by its competitors would definitely eat into Sohu’s market share.
 
Currently, we see limited upside for Sohu’s revenue and earnings growth in the near term. If the company can achieve the estimates for 2009, downside may not be significant. Although, we believe there are better opportunities but a recovery for the stock in the near-term is not envisioned.
 
Sohu is the third-largest Internet portal and a leading online brand in China. It is an Internet media, online gaming and search portal that provides a comprehensive package of online products and services to clients, primarily in China.

Read the full analyst report on SOHU

Read the full analyst report on SNDA

Read the full analyst report on BIDU

Read the full analyst report on NTES

Read the full analyst report on SINA