Sohu.com Inc. (SOHU) reported a loss of 52 cents per share in the fourth quarter of 2014, wider than the Zacks Consensus Estimate of a loss of 46 cents per share. In the prior year quarter, Sohu had reported earnings of 6 cents per share. The fourth quarter loss was due to a surge in operating expenses especially in its video business, which weighed on the company’s margins thereby reducing profitability.
Following the news, shares plummeted over 7.6% in yesterday’s trading session and finally closed at $51.62.
Revenues
Revenues increased 24% year over year to $477 million and also surpassed the Zacks Consensus Estimate of $459 million. The year-over-year increase was primarily driven by strong performance in all the segments.
Total online advertising revenues, which include revenues from brand advertising and search and others businesses, were $258 million, up 37% year over year.
Brand advertising revenues in the reported quarter totaled $148 million, up 20% year over year. The year-over-year increase was primarily driven by growth in online video and real estate advertising businesses.
Search and others revenues were $110 million, up 71% year over year. The year-over-year increase came on the back of an increase in the number of paid clicks and higher average cost per click.
Online game revenues for the quarter were $184 million, up 7% year over year. The year-over-year increase was primarily driven by the successful launch of the company’s new mobile game, TLBB.
Sogou’s fourth quarter revenues reached $119 million, representing a significant 70% year-over-year growth. Changyou’s performance remained healthy with modest revenues coming from its TLBB game while its TLBB 3D mobile game achieved strong gross revenues of about $65 million in its first two months.
Margins
Gross margin contracted 540 basis points (bps) from the year-ago quarter to 59%. The year-over-year decrease in gross margin was primarily due to increases in content and bandwidth costs.
Sohu’s operating expenses increased 42.4% in the quarter on a year over year basis to $195.6 million. The sharp increase in operating expenses hurt operating margins. Operating loss was $33.9 million in the reported quarter compared with $4.1 million loss incurred in the year-ago quarter.
Balance Sheet & Cash Flow
Sohu exited 2014 with cash and cash equivalents of $876.3 million compared with $1,287.3 million as of Dec 31, 2013.
Outlook
For the first quarter of 2015, Sohu expects revenues in the range of $425 million–$440 million while the Zacks Consensus Estimate for the same is pegged at $436 million.
Management estimates brand advertising revenues in the range of $130 million to $135 million, representing 17% to 22% year-over-year growth. Sogou revenues are expected to be in the range of $108 million to $113 million, representing 54% to 61% year-over-year growth. Online game revenues are expected in the $175 million–$180 million range, indicating year-over-year growth of 7% to 10%.
The company expects non-GAAP loss per share to be between 95 cents and $1.05. The Zacks Consensus Estimate for the same is loss of $1.85 per share.
GAAP loss per share is expected to be in the range of $1.15 to $1.25.
Our Take
We believe that Sohu is well positioned to benefit from strong traffic growth in search, online video and mobile businesses. Moreover, strong growth potential exists in the online gaming business. Additionally, the partnership with Tencent will boost Sogou’s traffic, which will further drive its top line going forward.
Further, 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 expand further over time.
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. The increasing expenses will keep margins under pressure in the near term but strengthen the long-term competitiveness of the company in China. Management is also taking initiatives like reducing its workforce to cut down on expenses.
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), AOL Inc (AOL) and such others in most of its operating markets.
Currently, Sohu sports a Zacks Rank #1 (Strong Buy).
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