Is Qihoo 360 the Next Baidu?

Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Most American investors are familiar with one Chinese stock above all others - search site Baidu (NASDAQ: BIDU). However, I think it’s time to take notice of a growing underdog in the Chinese search engine wars: Qihoo360 (NYSE: QIHU).

Baidu is often called the "Google (NASDAQ: GOOG) of China", since it controls 80% of the Chinese Internet search market. Its closest competitor is Google, with a steadily shrinking 15% share. In an earlier article, I advised investors to buy Baidu. 

Qihoo, better known as China’s largest antivirus software vendor, hasn’t generated any meaningful revenue from its search division yet. But it has already claimed 10% of the market in terms of search volume.

The New Underdog vs Baidu

Qihoo launched its search engine,, in August as a public beta. It quickly became the second-largest traffic source to websites such as a and Qihoo currently logs 411 million monthly users.

Later that month, Qihoo added its own search engine to its own portal site,, as well as its own web browser - the 360 Browser.

The 360 Browser is a popular browser in China, fusing Trident technology from Microsoft's Internet Explorer with the Webkit technology used in Google's Chrome and Apple's Safari. This allows the 360 Browser to pick up the optimal layout of the requested webpage and use the corresponding technology, resulting in faster load times and properly displayed pages.

Qihoo’s three-pronged web browser, portal, and antivirus attack is disruptive, and has forced Baidu to adapt to this new threat. Baidu recently began displaying notices to users referred to its portal sites through 360 search, alerting them to either set Baidu as their homepage or to add a shortcut to their desktops. Of course, this temporary fix might be seen more than an annoyance to users than a real solution.

The Foolish Fundamentals

Let’s compare Qihoo to Baidu in terms of pure fundamentals to decide which is a better value.

<table> <tbody> <tr> <td> <p><span><span><span><strong>Company</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Forward 12 Month P/E</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>5 Year PEG Ratio</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Price to Sales</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Price to Book</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Return on Equity </strong></span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span><strong>Qihoo</strong></span></span></span></p> </td> <td> <p><span><span><span>30.12</span></span></span></p> </td> <td> <p><span><span><span>0.93</span></span></span></p> </td> <td> <p><span><span><span>12.95</span></span></span></p> </td> <td> <p><span><span><span>8.39</span></span></span></p> </td> <td> <p><span><span><span>12.14%</span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span><strong>Baidu</strong></span></span></span></p> </td> <td> <p><span><span><span>18.46</span></span></span></p> </td> <td> <p><span><span><span>0.65</span></span></span></p> </td> <td> <p><span><span><span>11.63</span></span></span></p> </td> <td> <p><span><span><span>10.25</span></span></span></p> </td> <td> <p><span><span><span>50.39%</span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span><em>Best Value</em></span></span></span></p> </td> <td> <p><span><span><span><em>Baidu</em></span></span></span></p> </td> <td> <p><span><span><span><em>Baidu</em></span></span></span></p> </td> <td> <p><span><span><span><em>Baidu</em></span></span></span></p> </td> <td> <p><span><span><span><em>Qihoo</em></span></span></span></p> </td> <td> <p><span><span><span><em><span>Baidu</span></em></span></span></span></p> </td> </tr> </tbody> </table>

Fundamentally, Baidu wins by a landslide. However, investors should remember that the Chinese Internet sector is not really about value; it’s about momentum. Baidu spent years trading with a P/E north of 100 before it reached its current valuation.

In terms of youth and momentum, Qihoo has the upper hand, and since its market cap of $3.8 billion is a tenth of Baidu’s $38.4 billion, investors expect that it has more room to grow. It’s also important to remember that Qihoo generates most of its revenue from its antivirus software, and any gains from its search engine would only help boost its top line growth.

Macro Catalysts

Earlier this month, China posted 7.9% growth in its fourth-quarter GDP, exceeding estimates of 7.8%. Although it only narrowly beat forecasts, the growth is the first sign of a rebound in China, which has posted sequential declines since the fourth quarter of 2010.

In 2012, there were 538 million Internet users in China, an 11% year-on-year rise. Although that number looks formidable, it only represents 39.9% total penetration, meaning that the market could double before reaching maturity. The United States, by comparison, has an Internet penetration rate of 78%.

In the third quarter of 2012, China’s search engine market posted 13.5% quarterly growth, and year-on-year growth of 44.1%. These numbers appear strong, but they also mark the first time that the growth rate has fallen under 50%, due to the two-year slowdown in China. If China’s GDP is indeed rebounding, then major Internet players such as Baidu, Sina or Qihoo 360 could rally strongly in 2013 to regain lost ground.

Bottom Line

Qihoo started trading in the United States as an ADR in April 2011, making it one of the newer U.S.-listed Chinese stocks. The stock has been easily swayed by macro concerns regarding a slowdown in China as well as micro concerns regarding the accounting practices of Chinese companies.

Let’s take a look at the wild ride the stock took investors on since it went public, along with some key metrics, and see if we can spot any problems.

<img src="" />

data by YCharts

Qihoo 360 is facing is the classic problem with hot Internet stocks - rising revenue weighed down by contracting margins, rising expenses, and a shrinking cash hoard, which all reduce earnings per share. From these percentages, we can tell that Qihoo is spending a lot to increase its online presence with advertising.

Taking a look at this chart, it's easy to understand why Baidu is the better bet on China.

<img src="" />

data by YCharts

Baidu is growing every metric in the right direction, except for its stock price - making it an undervalued growth stockAlthough its operating margin has dipped slightly, it is more financially fit than its younger competitor. 

So despite Qihoo's aggressive moves into Baidu’s turf, I advise investors to stick with what they know best - Baidu - until the underdog can prove that it isn’t just another dog.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Baidu and Google. The Motley Fool owns shares of Baidu and Google. You can follow Leo Sun on Twitter at for more investing ideas.

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