Strategic trade
Trade view / 27 August 2015 at 1:42 GMT

Any news is good news for Qihoo privatisation

China Watcher / Shanghai
China
Instrument: QIHU:xnys
Price target:
Market price:
Background

Ahead of a more substantive earnings preview that I will post tomorrow, it’s worth discussing the importance of the conference call for Chinese tech firm Qihoo after its earnings release on September 1, which is currently subject to a management buyout bid that is looking less and less likely as each day passes.

At the time of the privatisation offer, it seemed like the right deal for Qihoo. The company has been perpetually undervalued by the market, simply because overseas investors don’t really understand what it does: Describing it as a search engine business would be ignoring half of the company’s operations.

The deal premium at the time of the announcement was 16.6%, which was by no means high relative to the wave of other Chinese firms that were actively announcing buyout bids. But two months later and a 40% drop in Chinese domestic equity markets, and the likelihood of the $77 buyout bid going through looks unlikely, particularly given that the share price closed last night at $48.17.

Qihoo’s share price since its 2011 IPO

Qihoo's Stock Price Since Its IPO Source: Stockcharts.com

The conference call is therefore of such importance to Qihoo shareholders, because the two most likely outcomes are that the buyout price will be lowered substantially, or the bid will be scrapped altogether.

Management won’t pay a 60% premium on shares, so something has to give. This forms the basis of the trade view, because there is so much uncertainty surrounding the company. With the share price sinking close to levels last seen two years ago, investors are simply looking for clarity.

Any information given on the outlook of the buyout bid would be a major positive for Qihoo’s share price, because it would help to give direction. Right now, uncertainty is weighing on the share price, because the market is expecting that the $77 bid won’t be fulfilled.

The financials over the past few years have been strong, and despite the seasonally-affected first quarter results looking disappointing in relation to previous earnings, both revenues and earnings were strong beats, continuing its near perfect earnings record since its 2011 IPO. However, the market doesn’t care, as there is very little correlation between Qihoo's earnings beats and its share price reaction.

The buyout bid is the elephant in the room, and management will have to comment on it. Failure to do so would be negligible on their part, as right now it is the most important consideration for Qihoo investors, and whether the buyout bid is cancelled or reduced, clarity is the most desired outcome.

Management and risk description

Volatility is a key issue at the moment, and is predominantly focused on the performance of the Chinese domestic equity markets and economy as a whole. This week’s rout in China has even seen serious doubts being raised about next month’s long expected Federal Reserve rate rise.

The problem is that it is difficult to predict what will happen over the coming days, as the general sentiment in China at the moment is that trading equities is akin to gambling. However, after an interest rate cut, a reserve requirement ratio cut, and further pledges of capital injection into equity markets, the reality is that the Shanghai exchange could be trading 500 points either side of last night’s close this time next week.

Adding to this the expected volatility from an earnings release, investors should be able to either stomach the risk of the trade or be able to effectively hedge.

Parameters

Entry:
$48.17.

Stop:
$45.

Target: $52.

Time horizon:
One month.


— Edited by Adam Courtenay

Non-independent investment research disclaimer applies. Read more

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