Sohu Remains Neutral

We maintain our Neutral rating on Sohu.com Inc. (SOHU). Although Sohu continues to face cut-throat competition from NetEase.com Inc. (NTES) and Take-Two Interactive Software Inc. (TTWO), we believe that its promising games portfolio and the continued popularity of Changyou.com Ltd. (CYOU) games will drive profitability over the long term.

Sohu reported strong fourth quarter 2010 results,primarily driven by growth in brand advertising, search ad business and online gaming. Both revenues and earnings beat the Zacks Consensus Estimate as well as its own guidance.

Earnings per share (EPS) of $1.07 (including stock-based compensation expense) increased 40.8% from 76 cents in the year-ago quarter but were flat from $1.07 in the previous quarter. The quarter’s EPS beat the Zacks Consensus Estimate of 98 cents.

Total revenue was up 27.0% year over year and 6.0% sequentially to $173.2 million in the reported quarter and surpassed the Zacks Consensus Estimate of $167.0 million.

The revenue was also above management’s expectation of $163.0 million to $168.0 million. The increase was primarily driven by robust growth in brand advertising, search business and online gaming revenues.

Sohu’s search engine, Sogou, has gained traction. As pointed out by management, active users of the Sogou browser, related search traffic and search revenue conjointly grew 20% sequentially in the reported quarter.

Online game revenues increased 30.0% year over year and 7.0% sequentially to $91.7 million, well above management’s guided range of $86.0 million to $89.0 million. The growth was primarily driven by an increase in demand for Tian Long Ba Bu (TLBB), Changyou’s flagship game in China.

Sohu provided an upbeat first quarter 2011 guidance that was above expectation. Sohu projects net income on a non-GAAP basis, after deducting the non-controlling interest in Changyou, in the range of $40.0 million to $42.0 million and earnings per share in the range of $1.03 to $1.08.

For the first quarter, Sohu expects total revenue in the range of $164.5 million to $169.5 million. This is higher than the Zacks Consensus Estimate of $162.0, provided at the time the company reported results.

Sohu estimates brand advertising revenues in the range of $55.0 million to $57.0 million. This implies a sequential decline of 5.0% to 8.0%, but an increase of 39.0% to 44.0% year over year.

The Zacks Consensus Analysts covering Sohu have raised their estimates for the first quarter and full year of 2011 in the last 30 days. Of the 9 analysts, 3 have raised their estimates for the first quarter while 7 have raised their estimates for the full year 2011.

The current Zacks Consensus Estimate for the quarter is 98 cents per share, up 3 cents over the last 30 days. Full year 2011 estimate is pegged at $4.61 per share, up 18 cents over the last month.

Sohu is expected to benefit from its strength in online games, online video growth, promising games portfolio and China’s growing online advertising industry. The company expects increased advertising spending in 2011.

Although results improved, the company witnessed a steady increase in operating expenses due to an aggressive investment strategy, which we fear could limit the earnings growth and pressure margins going forward. Moreover, recent delays in game launch and intense competition could further pressure performance.

The stock currently holds a Zacks #3 Rank, which translates to a short-term Hold rating.

SOHU.COM INC (SOHU): Free Stock Analysis Report

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