The Changing Landscape of China's Search Market

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Despite its dominance in China’s search market, Baidu (NASDAQ: BIDU) is losing market share. Yet, it is Google that suffered the most. While Sogou.com, soso.com, and Qihoo 360 (NYSE: QIHU) all gained market share since 2012, there is only one apparent winner, Qihoo 360, whose fast growth continues in 2013 as its market share jumped from 10.59% at the beginning of 2013 to 15.18% in May.

<table> <thead> <tr><th> </th><th> <p>2012 Market Share</p> </th><th> <p>May, 2013 Market Share</p> </th></tr> </thead> <tbody> <tr> <td> <p>Baidu</p> </td> <td> <p>78.6%</p> </td> <td> <p>67.55%</p> </td> </tr> <tr> <td> <p><strong>Qihoo 360</strong></p> </td> <td> <p><strong>N/A</strong></p> </td> <td> <p><strong>15.18%</strong></p> </td> </tr> <tr> <td> <p>Google</p> </td> <td> <p>15.6%</p> </td> <td> <p>3.29%</p> </td> </tr> <tr> <td> <p>Sogou.com</p> </td> <td> <p>3.1%</p> </td> <td> <p>8.48%</p> </td> </tr> <tr> <td> <p>Soso.com</p> </td> <td> <p>1.5%</p> </td> <td> <p>3.99%</p> </td> </tr> <tr> <td> <p>Youdao.com</p> </td> <td> <p>0.3%</p> </td> <td> <p>0.26%</p> </td> </tr> <tr> <td> <p>Others</p> </td> <td> <p>1.0%</p> </td> <td> <p>0.09%</p> </td> </tr> </tbody> </table>

Source: Chinese Search Engine Market Share from China Internet Watch

Qihoo 360 buying Sogou.com?

Earlier in July, Baidu agreed to buy 91 Wireless for $1.9 billion. Baidu is seeking a new channel for app distribution, which can be integrated with Baidu’s other mobile services and apps. With this whopping $1.9 billion deal, Baidu is showing its determination and urgency to step up its expansion into the mobile market.

Qihoo, which owns the most-used web browser and the second most-used search engine in China, will be facing stronger competition from Baidu after it acquired 91 Wireless, the No. 2 player in app distribution. Qihoo’s Mobile Assistant is currently the leading player in the market. To boost its competitiveness, Qihoo is reported to be talking to Sohu (NASDAQ: SOHU) to acquire its search unit, Sogou.com.

Strategically, it makes perfect sense for the No. 2 and No. 3 players to combine their market share and strengths to fight against the dominant player, Baidu. However, Qihoo is trying to figure out if Sogou.com can be integrated into its operation. On the other hand, Sohu is exploring options for Sogou.com, including finding minority investors or pursuing a combination.

At the same time, Qihoo has declined the rumor for its potential acquisition of a mobile gaming company, Chukong Technologies. Qihoo remains focused on expanding it search business.

On the Sohu side, there are several incentives for Sohu to find a strategic solution for Sogou.com. First, the competition in the search market has intensified, and Qihoo has been gaining market share at a faster rate as compared to Sogou.com. Second, Sohu, as a diversified company, has several other monetization opportunities to focus and expand on, such as mobile video and Sohu News. Third, from a financial perspective, Sogou contributed only $39 million of revenue in the first quarter, which was significantly smaller compared to its online game revenue of $167 million.

Sohu has confirmed that it has been exploring options for Sogou. As reported by the company, "Options being considered for Sogou include continuing to grow its strong product offering with the existing minority shareholder base, seeking additional strategic minority investors, or pursuing a more comprehensive strategic combination."

What now?

Baidu has shown its card with the 91 Wireless acquisition, and it is time for Qihoo to respond. While Qihoo’s share price has gained over 283% year-to-date, as compared to Baidu’s near flat performance, Qihoo’s top priority is to maintain its high growth and continuously increase its market share.

At a current P/E of over 196, as compared to Baidu’s P/E of 22, Qihoo needs much stronger growth to sustain its valuation. By combining with Sogou.com, which is also gaining market share, Qihoo will instantly scale up and close its gap with Baidu. Any positive development between Qihoo and Sohu will be a positive catalyst for Qihoo’s share price.

Bottom line

The growth rate for Qihoo will remain the key factor for investors. Qihoo has every reason to acquire Sohu if it can successfully integrate its operation to leverage the combined market share. The Sohu deal will remain a short term positive catalyst for Qihoo’s share price, which in the long-term will certainly help Qihoo to enhance its competitiveness in the Chinese search market.

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Nick Chiu has no position in any stocks mentioned. The Motley Fool recommends Baidu and Sohu.com. The Motley Fool owns shares of Baidu. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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