Sohu Misses on Higher Expenses - Analyst Blog
October 31 2011 - 10:02AM
Zacks
A leading online brand and Internet portal in China,
Sohu.com Inc.’s (SOHU) third quarter 2011 earnings
missed the Zacks Consensus Estimate by a penny. Earnings per share
(EPS) of $1.17 (including stock-based compensation) increased 15.8%
from $1.01 reported in the year-ago quarter.
However, reported EPS fell short of the company’s guided range
of $1.20 to $1.25. The miss was primarily attributed to higher
operating expenses in the quarter. Third quarter earnings exclude
Sohu’s non-controlling interest in the online gaming company
Changyou.com Ltd. (CYOU).
Operating Performance
Gross profit surged 37.3% year over year to $166.0 million.
Gross margin on a non-GAAP basis was 71.3%, down 230 basis points
(bps) from the year-ago quarter.
The company’s margins were affected by the year-over-year
decline in online games gross margin, which stood at 87.4% versus
91.6% in the year-ago quarter. Wireless gross margin decreased to
38.6% from 45.7% in the third quarter of 2010.
Online brand advertising gross margin was 58.7% in the reported
quarter, down from 60.6% reported in the prior-year quarter. Gross
margin for the Search business was 59.1%, up significantly from
31.9% reported in the year-ago quarter, due to higher volumes.
Operating expenses shot up 66.0% year over year to $92.3 million
in the quarter due to higher product development cost (up 43.8%
year over year), sales & marketing expense (up 91.4% year over
year) and general & administrative expense (up 45.5% year over
year).
Operating profit increased 12.8% year over year to $73.6 million
due to strong top-line growth. However, operating margin plummeted
820 bps to 31.6% in the quarter, primarily due to higher operating
expenses.
Revenue
Total revenue increased 42.0% year over year to $233.0 million
in the reported quarter and surpassed the Zacks Consensus Estimate
of $226.0 million.
Reported revenue also exceeded management’s expected range of
$225.0 million to $230.0 million. The increase was primarily driven
by higher brand advertising, strong search business and online
gaming revenues.
Brand advertising revenue in the quarter grew 29.6% year over
year to $76.6 million, in line with the high end of management’s
guided range of $75.0 million to $77.0 million. The
better-than-expected results were mainly driven by the increasing
number of brand advertising customers and strong advertising demand
from the IT and real estate sector.
Search revenue soared 243.7% year over year to $18.4 million in
the reported quarter. The year-over-year growth was mainly driven
by increased search traffic and improved monetization of
traffic.
Online game revenue increased 35.2% year over year to $115.8
million, surpassing management’s expectation of $112.0 million to
$114.0 million. The upside was mainly due to the continued
popularity of Tian Long Ba Bu (TLBB) in China, full
quarter revenue contribution from 7Road (acquired by Changyou in
the second quarter) and higher revenue contribution from the newly
launched game Duke of Mount Deer (DMD).
Online gaming revenues grew on the back of higher active paying
accounts (APA) and user base expansion. Aggregate registered
accounts for Changyou's games jumped 51.0% year over year. Average
revenue per user (ARPU) spiked 2.0% year over year. Aggregate peak
concurrent users for Changyou’s games were approximately 3.0
million, up 17.0% year over year.
Wireless revenues increased 4.5% from the year-ago quarter to
$14.2 million.
Balance Sheet
As of September 30, 2011, Sohu had a cash position of $729.7
million compared with $737.9 million at the end of June. At the end
of the quarter, Sohu had no debt on its balance sheet.
Outlook
Sohu provided an upbeat guidance. For the fourth quarter, Sohu
expects total revenue in the range of $241.0 million to $246.0
million. Sohu reported revenues of $173.2 million in the year-ago
quarter.
Sohu estimates brand advertising revenues in the range of $77.0
million to $79.0 million, implying a sequential growth of 1.0% to
3.0% and year-over-year growth of 28.0% to 32.0%.
Revenue from Changyou is expected to be between $122.0 million
and $125.0 million, of which revenues from online games are
expected in the $119.0 million to $122.0 million range. Management
anticipates Sogou revenues of $21.0 million for the fourth quarter,
which implies a year-over-year growth of 218.0% and sequential
growth of 14.0%.
Sohu projects net income on a non-GAAP basis, after deducting
the non-controlling interest in Changyou, in the range of $50.5
million to $52.5 million and EPS in the range of $1.30 to $1.35.
The current Zacks Consensus Estimate for the third quarter is
pegged at $1.25 per share.
Recommendation
Sohu is expected to benefit from its strength in online games
and China’s growing online advertising industry. The company is
also expected to benefit from strong growth in the online video
market and upside in advertising spending for 2011. We believe that
Sohu’s promising games portfolio and the growing popularity of
Changyou’s games will drive profitability over the long term.
However, Sohu continues to face cut throat competition from
Baidu Inc. (BIDU) and Sina Corp.
(SINA), which will hurt its profitability going forward. Moreover,
increasing government scrutiny in the Chinese internet is also
expected to hurt Sohu’s growth over the long term.
We, therefore, maintain our Neutral recommendation on the stock
over the long term. Currently, Sohu has a Zacks #3 Rank, which
implies a short-term Hold rating.
BAIDU INC (BIDU): Free Stock Analysis Report
CHANGYOU.COM (CYOU): Free Stock Analysis Report
SINA CORP (SINA): Free Stock Analysis Report
SOHU.COM INC (SOHU): Free Stock Analysis Report
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