Article / 28 August 2015 at 0:32 GMT

Earnings Preview: Qihoo’s elephant in the room

China Watcher / Shanghai
China
  • Qihoo's privatisation bid must now be dead in the water - it's now too high
  • Clarity on the situation may see a positive share price reaction
  • Qihoo's three new Android phones should fit well into the middle market
  • An interesting tech dynamic is now growing between Qihoo and LeTV

By Neil Flynn

Chinese tech firm Qihoo has been on quite a rollercoaster ride since its last earnings release. After a strong beat on the top and bottom line, the company maintained its reputation of being consistently mistreated by the market, and fell 8.8% the following day.

Since then, it has announced a $10 billion privatisation bid that valued the firm at $77/share when trading at $66.05, and then has been a major casualty of China’s domestic woes, closing last night at $51.29. Here are the three major focal points for investors ahead of the earnings release on September 1.

Time to come clean


An argument that I posed yesterday is that the outstanding privatisation offer, that represents a 50% premium over last night’s close, is all but dead in the water, which is disappointing because the case for de-listing from the US and relisting in China makes perfect sense for Qihoo.

However, with the 22% fall in share price since prior to the announcement being made, the valuation of the bid is far too high. This poses the question of what management will do. There are three options available, two of which investors will be hoping are announced during the earnings call.

Firstly, the privatisation bid is tabled at a lower price. I believe that this is the most likely outcome, because the fundamentals of privatisation continue to be the best option for the firm. It has been perpetually undervalued in the US, simply because investors don’t really understand what it does.

Whilst there may be concerns about the ability to raise the capital for the buyout bid, financing liquidity has improved in China since the end of June, so it shouldn’t be an issue for the firm. The second option would be that the buyout bid is taken off the table indefinitely. This is a possibility, but I believe that it would only be temporary, as the firm would look to re-table a buyout bid in the near term.

The key point here is that the market is already expecting that the current bid won’t be completed, and the argument that I posed yesterday was that clarity on the situation may see a positive share price reaction in the short term.

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 Qihoo's privatisation bid: Certain things need to be clarified. Photo: iStock

Management must comment on the status of the buyout bid because it is the major concern for all of Qihoo’s investors. The worst thing that they can do is the third option: say nothing at all.

Release of the new smartphones


Earlier this week, Qihoo announced that it has launched three Android smartphones through its joint venture with domestic manufacturer Coolpad. The phones will be priced in the budget and mid-priced market, which will see it compete directly with China’s array of cheap domestic smartphones, as well as lower-end Samsungs.

There had initially been concerns that the joint venture was expecting to target the high-end market by providing a domestic rival to Apple’s iPhone after comments from CEO Zhou Hongyi, but it was eventually denied by the company, suggesting either a misunderstanding or common sense prevailing.

The launch of the smartphones is timed well for investors, because I expect that the management conference call will focus heavily on the prospects of the new phones. Qihoo has been actively investing into its hardware business, and the collaboration with Coolpad will see a culmination to this investment.

An interesting dynamic to this is the investment in Coolpad by LeTV, which sees itself as a disruptive company in more ways than one. Founder and CEO Jia Yueting has had several public spats with other tech CEOs, such as Xiaomi’s Lei Jun.

The problem that LeTV causes for Qihoo is that both firms are developing their own smartphone business. LeTV has recently launched its own range of phones, and sees the investment in Coolpad as a way to develop its own technology in order to compete with Xiaomi.

Likewise, Qihoo invested in Coolpad in order to combine Coolpad’s hardware capabilities with Qihoo’s operating system and software. The problem for Qihoo is that it if its technology is used in Coolpad Dazen smartphones, it is likely that it would influence Coolpad’s other smartphones, and hence LeTV’s smartphones.

It likely won’t be discussed in detail during the conference, given the reported expletive-filled rant by Qihoo’s CEO Zhou Hongyi on social media after LeTV’s investment was announced.

However the deal will influence the future of the collaboration between Coolpad and Qihoo. The original expectation was that if the new range of smartphones proved to be successful, then Qihoo would buyout Coolpad.

But with LeTV now owning a sizeable stake, Qihoo will either have to buyout LeTV’s stake, at a large premium, or abandon the partnership with Coolpad altogether, assuming that Messrs Zhou and Jia can’t learn to get along.   

Is Qihoo taking a backseat in O2O?

Just like mobile ecosystem in 2014, the buzzword of 2015 among Chinese tech firm is online to offline (O2O). Unlike mobile ecosystem, O2O is a business that doesn’t exist in the developed world, and can only really work in emerging economies.

As a brief overview, the concept is to get offline services onto online devices, primarily the smartphone, so that through an O2O app, a user can order takeaway food, hail a taxi, and even find a chef to come to your house to cook a three-course meal.

In theory, this could work in the developed world, but the cost of labour in China is so cheap that it makes O2O essential to everyday life.

Qihoo’s entry into O2O has been passive, to say the least. It released the 360 Merchant Connect app at the end of last year, which is designed to connect restaurants with Qihoo’s mobile users.

While the firm has a lot of mobile users of its security apps and search engine, the reality is that no one uses its O2O app. But this isn’t to say that Qihoo has failed. Having an app that allows users to connect with offline services is essential, particularly for a leading search engine such as Qihoo.

Likewise, no one will be competing with the firm in mobile security in the near term, so its large user base will be safe and it makes sense to at least offer the service. But unlike larger rivals such as Baidu, which is spending billions of dollars on developing its O2O business, Qihoo is seemingly taking a backseat.

The major players in the industry are, unsurprisingly, the BAT trio of tech giants: Baidu, Alibaba and Tencent, who can (and always do) outspend any smaller rivals, and have the largest mobile user bases in China.

It is in Qihoo’s best interest to continue to invest heavily in its hardware and security products. Offering some O2O services is required in China, but I would be very disappointed if management commits to spending heavily on the business.

-- Edited by Adam Courtenay

Neil Flynn is a China watcher based in Shanghai. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform
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