Shares of Sohu.com Inc. (SOHU - Analyst Report) declined 5.0% over the week due to worst-than-expected first-quarter 2014 results. The company reported loss of $1.33 per share in the first quarter of 2014, which compared unfavorably with earnings of 60 cents reported in the year-ago quarter.
The reported loss was, however, narrower than the Zacks Consensus Estimate of a loss of $1.45 per share. The loss can be attributed to a massive surge in operating expenses related to compensation and promotional activities.
Revenues jumped 18.8% year over year to $365.3 million and beat the Zacks Consensus Estimate of $363.0 million. The year-over-year increase was primarily driven by strong performance from online advertising, brand advertising and search & other segments, which more than offset the decline in revenues in the Online Games segment.
Total online advertising revenues, which include revenues from brand advertising and search and others businesses, were $175 million, up 51% year over year.
Brand advertising revenues in the reported quarter totaled $111.0 million, up 38% year over year. The year-over-year increase was mainly due to growth in online video and real estate advertising businesses.
Search and others revenues were $64.0 million, up 78% year-over-year. The year-over-year increase was mainly due to increased traffic and improved monetization, as well as due to the effect of synergies from the Soso business acquired in the third quarter of 2013.
Online game revenues for the first quarter of 2014 were $163.0 million, down 2% year-over-year.
Starting from the first quarter of 2014, Sohu will no longer report “mobile” as a separate business line. Instead, it will combine “mobile” into the “other” business as the company believes that the mobile business is no longer significant enough to constitute a separately disclosed business line.
In the first quarter, total average monthly active accounts of the platform and software applications reached $239 million, which was a 60% increase from the previous quarter.
In the reported quarter, mobile video traffic surpassed PC traffic. For Sogou, the mobile Pinyin has not only emerged as the third most popular app in China, but also happens to be the number two player in mobile search area with traffic growing north of 20% sequentially.
Sogou’s first quarter revenues reached $175 million, representing a decent 78% year-on-year growth, which topped the prior guidance. Mobile search revenues accounted 12% of total search revenues.
According to iResearch, Sohu Video Entertainment Report, a daily show that covers the popular entertainment events, gained strong traction after breaking some exclusive news and currently happens to be the second most watched variety show.
During the quarter, Sohu expanded coverage on Hop animated series, which is very popular with the youth. Sohu has also secured the exclusive rights for popular series such as One Piece, Fairy tale (inaudible) and Hunter and Hunter, Chen Julian.
Moreover, Sohu has a few exciting original productions in its pipeline including Secretly Greatly (inaudible), a practical joke celebrity reality show that is shot with hidden cameras. It happens to be the first company in China to produce such a brand new category of content.
Such high quality content helped to draw more viewers for both PC and mobile video platforms. Mobile traffic showed stronger momentum and exceeded PC during the reported quarter.
Gross margin contracted 420 basis points (bps) from the year-ago quarter to 62.1%.
Operating expenses jumped 121.9% year over year to $295.4 million. Operating expenses, as a percentage of revenues, were 80.9% compared with 43.3% in the year-ago quarter.
The year-over-year increase in operating expenses was mainly due to an increase in salaries and compensation expenses as a result of increased headcount and higher marketing and promotional expenses.
The sharp increase in operating expenses hurt operating margins. Operating loss was $68.6 million in the reported quarter compared to a profit of $70.9 million in the year-ago quarter.
Net loss attributable to Sohu was $51.0 million compared to net profit of $23.0 million in the year-ago quarter.
Balance Sheet & Cash Flow
Sohu exited the first quarter with cash and cash equivalents of $1.14 billion compared with $1.28 billion in the previous quarter. In the first quarter, Sohu generated $35.0 million in operating cash outflow compared to cash flow of $129.0 million in the prior quarter. Operating cash outflow for Changyou was $16.0 million while that for other business units was $19.0 million.
For the second quarter of 2014, Sohu expects revenues in the range of $397.0 million–$411.0 million.
Management estimates brand advertising revenues in the range of $130.0 million to $135.0 million, representing 30.0% to 35.0% year-over-year growth.
Sogou revenues are expected to be in the range of $86.0 to $90.0 million, representing 72.0% to 80.0% year-over-year growth. Online game revenues are expected in the $161.0 million–$166.0 million range.
Non-GAAP net loss is expected in the range of $48.0 million to $52.0 million while loss per share is projected between $1.25 and $1.35 per share. The Zacks Consensus Estimate stands at a loss of $1.21 per share, which in turn happens to be way below the mid-point of the management guidance range.
Managements expects Sogou revenues to rise 20.0% sequentially. Sogou is expected to achieve the target of $100.0 million in operating revenue in the second quarter.
We believe that Sohu’s innovative product pipeline and strong traffic growth in the search, online video and mobile businesses will drive top-line growth, going forward. Moreover, strong growth potential exists in the online gaming business. Additionally, the partnership with Tencent will boost Sogou’s traffic, which will further drive Sohu’s top line going forward.
Additionally, with continued organic growth and the support of Tencent's vast online properties, Sogou's market share in PC and mobile search is expected to further expand over time. However, we believe that there is still substantial room for Sogou to improve its search monetization capability.
However, Sohu is a relatively small player in the online advertising market and continuing investments in product development are necessary to expand its market share. This will keep margins under pressure in the near term but strengthen the long-term competitiveness of the company in China. Despite higher spending, we believe that market share gain will be difficult in the near term due to stiff competition from the likes of Baidu, Inc. (BIDU - Snapshot Report) , Akamai Technologies (AKAM - Analyst Report) and such others in most of its operating markets.
Currently, Sohu has a Zacks Rank #3 (Hold). Other better ranked stocks include Expedia Inc (EXPE - Analyst Report) with a Zacks Rank # 2 (Buy).