Sohu's future may have plenty to do with Tencent
- Sohu can't compete with bigger firms on TV content
- Subsidiary Changyou getting less from its current portfolio of games
- Tencent likely to acquire a larger stake in Sogou
By Neil Flynn
Sohu has reached a period of uncertainty, regarding the sustainability of its revenues. Other than the search engine Sogou, all revenue streams are seeing decreasing margins. With rising content costs for TV program, and one of China’s most popular online games coming to the end of its lifecycle, falling margins are likely to continue.
In Sohu’s second quarter earnings conference call, CEO Charles Zhang discussed how the price structure for foreign TV content is too high. This is because the market is relatively new, and there are a lot of firms with large financial backing that are able to bid content costs higher. Sohu is guiding year-on-year video advertising revenues to fall from 80% to 40% in the third quarter. Last year Sohu had the rights to The Voice Of China 2, which is China’s most popular show, but lost the rights for the third season to Tencent.
Changyou has been releasing expansion packs which helps to reduce the difficulty for users. But the big spending players will have already completed the game, which means that the game currently only generates revenue from the small spending and casual gamers.
Changyou has discussed that it is releasing a new portfolio of games in the second half of the year. This creates further uncertainty about revenues, because these new games need to replicate the success of TLBB and attract the high spending gamers. Another source of uncertainty comes from Tencent expanding its own game network on its WeChat and Mobile QQ platforms, which makes it a very large competitor in the market.
I believe that there are two likely outcomes for Sohu’s future. Firstly, I expect Tencent to acquire a larger stake in Sogou. Tencent has recently been closing down its unprofitable and unpopular businesses, such as its Weibo microblogging service and its search engine Soso, so as it is integrating Sogou into its ecosystem, I expect Tencent to increase its stake or pursue an outright acquisition.
In addition, Tencent was originally an online game company, and its WeChat and QQ Mobile platforms have seen new games added. A large stake in Changyou would improve the quality of games on the two platforms.
-- Edited by Adam Courtenay
Neil Flynn is head equity analyst at Chinese Investors