Sohu.com Inc. (SOHU) reported earnings of 6 cents per share in the fourth quarter of 2013, which decreased 90.2% year over year and 87.0% on a sequential basis. Earnings were much better than the Zacks Consensus Estimate of a loss of 34 cents.
Revenues
Revenues jumped 28.7% year over year and 4.7% sequentially to $385.5 million but missed the Zacks Consensus Estimate of $387.0 million. The year-over-year increase was primarily driven by strong performance from online advertising and other segments.
Online advertising revenues surged 55.4% year over year and 6.0% sequentially to $187.7 million. The year-over-year growth was primarily driven by strong performance from online video, Sogou, search and brand advertising.
Sohu video continued to maintain its dominant position, driven by a content portfolio that includes American television drama series, Japanese animation series, domestic variety shows and in-house programs. Sogou completed a smooth integration with Tencent’s Soso, with revenues hitting the high end of the guidance.
Sogou revenues continued to grow in the quarter, up 72.0% year over year and 23.0% quarter over quarter to $70.0 million. Sogou Pinyin Mobile Version now has over 180 million monthly active users.
Search and Others revenues jumped 66.4% from the year-ago quarter and 23.1% sequentially to $64.4 million.
Brand advertising revenues grew 50.3% from the year-ago quarter to $123.3 million and were close to the higher end of management’s guided range of $120.0 million to $125.0 million. Revenues increased 24.5% sequentially. Brand advertising continued to benefit from strong traffic driven by an improving online video business.
Online games revenues, operated by Changyou.com (CYOU) increased 8.7% year over year and 6.5% sequentially to $171.9 million, toward the lower end of management’s expectation of $171.0 million–$176.0 million.
Mobile revenues decreased 21.3% year over year and 31.6% quarter over quarter to $9.9 million. Others revenue surged 99.5% year over year and 4.1% sequentially to $15.9 million in the reported quarter.
Margins
Gross margin contracted 440 basis points (bps) from the year-ago quarter to 68.8%. On a sequential basis, gross margin decreased160 bps.
Operating expenses, as a percentage of revenues, were 65.4% compared with 47.3% in the year-ago quarter. On a sequential basis, operating expenses as a percentage of revenues increased 1360 bps in the 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 increased marketing and promotional expenses. The sequential increase was primarily due to an increase in Changyou marketing expenses associated with a series of new products.
The sharp increase in operating expenses hurt operating margins. Operating loss was $4.1 million in the reported quarter as compared to a profit of $64.4 million in the year ago quarter and a profit of $52.3 million in the prior quarter.
Net income was $2.27 million as compared to $23.1 million in the year ago quarter and a net loss of $65.0 million in the prior quarter.
Balance Sheet & Cash Flow
Sohu exited the fourth quarter with cash and cash equivalents of $1.28 billion compared with $1.24 billion in the previous quarter. In the fourth quarter, Sohu generated $129.0 million in operating cash flow compared to $124.0 million in the prior quarter. Changyou generated $83.0 million, while operating cash flow for the other business units were $46.0 million.
Outlook
For the first quarter of 2014, Sohu expects revenues in the range of $355.0 million–$367.0 million while the Zacks Consensus Estimate is pegged at $362.0 million.
Management estimates brand advertising revenues in the range of $110.0 million to $115.0 million, representing 37.0% to 43.0% year-over-year growth. However, on a sequential basis, brand advertising revenues are expected to decline 7.0% to 11.0%.
Sogou revenues are expected to be in the range of $67.0 to $69.0 million, representing 70.0% to 76.0% year-over-year growth but to decline 2.0% to 5.0% on a sequential basis. Online game revenues are expected in the $160.0 million–$165.0 million range.
Non-GAAP net loss is expected in the range of $42.0 million to $46.0 million while loss is projected between $1.10 and $1.20 per share. The Zacks Consensus Estimate stands at earnings of 24 cents per share.
The company has a robust product pipeline for 2014 including 3 MMO games, 5 web games and over 10 to 15 mobile games.
Akamai expects to increase its investment on video content acquisition by about 23.0% year over year. With the rapid increase in the mobile traffic management expects to increase the investment on bandwidth as well.
Our Take
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 still 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 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), Akamai Technologies (AKAM) and such others in most of its operating markets.
Currently, Sohu has a Zacks Rank #3 (Hold).
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