The Most Undervalued And Misunderstood Chinese Internet Stock

On May 2, 2011, Citron reported on Sky-Mobi when the stock was $18. Citron placed a price target of $3 on the stock, pointing out the company's outdated business model and documenting its gross representations of itself to Wall St. So then, Sky-Mobi kicked and screamed. They held a conference call to refute our critique, and multiple analysts upgraded their stock ratings and raised targets. Not more than 4 months later, in spite of the protests, the MOBI traded at $3 — not because of Citron, nevertheless rather the inevitable fate of their business model's value.

Company with many similarities

Citron explores today a company with many similarities, Qihoo 360. We estimate that it is headed to $5 per share, more than 75% below its current trading range. Sky-Mobi and Qihoo have both on purpose misrepresented their businesses to Wall St in the hope of sustaining exaggeratedly high market capitalizations, however in both cases Citron's analysis points decisively to the conclusion that their best days are behind them, not in front of them.

Qihoo went public on purpose. In the spring of 2011, all Chinese Internet stocks were entering bubble territory. Sina Corp. was approaching $150 per share and Yoku.com was over $50. With scant earnings, Qihoo claimed some bold benchmarks in their prospectus and their most recent quarterly statement. Once you have read our findings, you will see those claims in a different light.

So this is where they are today, a web 1.0 brand with a web 1.0 business model in other words hoping to be moving into mobile, cloud computing, and search — all businesses in which they are years behind and have zero present-day market share.

Before going into their earnings and business model, let's address those big market share numbers that are thrown in the face of the investment community on page 1 of their prospectus. Those numbers are greatly exaggerated or misleading to say the best. According to their prospectus and recent filings they claim :

The company boasts they have "over 300 million active users", "80% penetration", and are "the 3rd largest Chinese internet company by active user base". We find that, based on independent metrics, the truth shows no resemblance to that.

More than 21% of QIHU's earnings are derived from Google, primarily be referring search queries. According to Doubleclick ad planner as powered by Google, 360.cn is the 21st most visited site in China with a reach of only 10%.

The sake of comparison in this report

For the sake of comparison in this report, we will compare Qihoo to Sohu and PhFENG. Two publically traded Chinese Internet Companies who have ad based models similar to Qihoo.

* When comparing to SOHU, we have to credit SOHU's 67.1% ownership of CYOU, worth $600 to $885 million to boot to SOHU's enterprise value for the balance of its business.

* What makes comparing these 2 companies moreover ridiculous is the mindshare perspective. SOHU is number 7 on the Google Doubleclick ranking and number 9 on Alexa respectively. From point of few of internet ranking, the gap from #7 to #21 is massive – about 3 to 7-fold in terms of overall web presence. And just in case, SOHU owns 65% of SOGOU.com, a search site which spontaneously outranks QIHU in both Alexa and Doubleclick.

Link to an interview given

Here is a link to an interview given by Zuoli Xu, CFO of QIHU along with Yu Yao, their VP, in which management admits their lack of a current compelling business model and describes their hopes for the future. When Citron reads this interview, it seems more like the banter of an internet startup company knocking on doors to raise money – not that of an established $2.5 billion dollar internet standard bearer.

QIHU's CEO is a gentleman named Zhou Hongyi. Previously he founded Qihoo, he founded a company called 3721 which became one of China's first search engines that he sold to Yahoo in 2003 for $120 million. " Nevertheless 3721′s software had become popular by lodging itself in computers as spyware. It introducing pop-windows, bedeviling its users — and some would say it introduced spyware into China."

Because of his "arrogance" and inability to hire English speaking workers and be trusted Zhou was forced out of Yahoo, which as you can imagined ended in a series of lawsuits. Zhou Hongy's reputation to be trusted got so bad that in late 2010, previously China Internet mania struck, it was even though that Qihoo would never be able to go public because of their CEO, and the opportunity that they have not left their spyware roots behind them. In something that we have never seen, Zhou's reputation got so soiled that Yahoo CEO encouraged western investors as recent as December 2010 "not to trust his old acquaintance from China".

If Qihoo was a U.S. Internet company, it could never have gone public because of its litigation history and questions surrounding its business model. Citron's $5 is generous. Qihoo should to tell the truth be trading at a considerable discount to any comparable valuation strictly on the questionable nature of management's judgment, as described by Citron, nevertheless rather by many internet business leaders in China as then as the courts.

As QIHU was preparing for its IPO, there corporate actions resembled those of a company fighting for its survival. The browser was losing market share and they were becoming insignificant in the rapidly changing face of the Chinese internet market. QIHU's choice of action was to try to muscle competitors off the desktop. Its installations forced users to uninstall competitor’s products, at times with misleading prompts. This led to a very ugly public squabble, with accusations of spying and leaking users private information, as so then as expressly releasing malware. As the attached link shows, QIHU went to war with leading instant message platform QQ, a major anti-virus competitor Kingsoft, and search leader BIDU.

Does anyone believe this?. Qihoo is not even a current participant in the mobile security space, aside from a claim last month to have launched mobile internet browsers. The fact is to date it has generated 0 revenue from mobile services. This fact is indisputable from the company's most recent 10-Q.

The rhetoric

Once you get past all the rhetoric and "netspeak," you are left with a web 1.0 company that publishes a browser that at one time was getting a lot of installs, however is now hustling to try and find its place in a brutally competitive and fast changing internet landscape, out-invested and out-gunned by larger competitors.

With no disruptive research and no fast growing properties Qihoo has ... a browser ... in other words it … plain and simple.

History lesson

For those of you who need a history lesson, a browser is not a business, it is a tool. The grandfather of all browsers Netscape is now shut down, and a non-profit company now owns its browser.

A browser is not a business in the U.S. and it is not a business in China. Dong Xu, a researcher with Analysys International, states:

The browser

And even for their one standing business being the browser, the bad news is that competition has come to town. Baidu, a company with over 75% of the search market has recently launched their own browser that has a focus on internet security.

BIDU's new browser is being released to cement its position as the unquestioned leader in search, much as Google developed Chrome to make sure it had a foothold with web surfers, not to generate a revenue stream, however to assure Google's hold on the search business.

We look forward to their strident defense of this name, and hope they present some data more substantive than management's hopeful narrative. We suggest independent investors seek out and give more weight to independent data points especially those that would verify the range of Qihu's real earnings, and less to company stated "future plans," expecially where those plans have generated no earnings.