Qihoo, Yahoo: Reasons to Buy or Sell

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

Qihoo and Yahoo are digital media companies that are in total contrast to one another. While Yahoo has several years in the business, Qihoo is new. While Yahoo is globally established, Qihoo has just started in China. However, their growth patterns indicate that Qihoo is growing at a faster rate while Yahoo, which had almost become dormant, is slowly rising to its feet. Has the market properly acknowledged the two different growth stories?

Qihoo (NYSE: QIHU): A Rising Giant?

Out of seemingly nowhere, Qihoo launched a new search engine to gain a share of 10% of traffic within just two weeks. This is something search entrants would never even dare to dream about in the United States with Google (NASDAQ: GOOG) being a static leader. Hongyi Zhou, the CEO, is good at public relations, and he has managed to convince people that Qihoo is a great threat to Baidu. Initially, Qihoo had used Google as the default search engine when there were 303 million users by September. But Google decided to pull out amidst the controversy surrounding Chinese censorship laws. While US social rights activists praised the move, it wasn't necessarily a step in the right direction for the bottom-line. Recent rumors that Qihoo will soon be re-partnering with Google China (presumably in default search) should send off alarm bells in Baidu's headquarters.

Since companies are valued based on the future and not the past, it's important to look where Qihoo is heading. Fortunately, Qihoo is on a strong trajectory. It recently reported that it was building an advertising platform and increasing its sales staff. Some former Google employees are already working for Qihoo in an attempt to get 15%-20% of the search market in China. Although Qihoo has a small market share, it could make Baidu’s cost of acquiring traffic increase as it tries to prevent them from crossing over. Qihoo has already released a mobile app to compete with Baidu, adding that they will center their mobile hardware on games. It has also launched a music search engine that is aimed at competing with that of Baidu. There is an existing partnering with Lenovo to sell the LePhone A586 smartphones. These phones offer Baidu’s cloud services and run on Android.    

Yahoo (NASDAQ: YHOO): Why to Buy, Why to Avoid

Yahoo used to be a great web directory and still is. However, it has experienced some problems along the way that have led to losses. Only two years ago, Yahoo struck a huge deal with Microsoft to enter Bing results in Yahoo search pages. Many Yahoo subscribers have since shifted to other information providers. In the past, I have written prolifically about Yahoo's troubled past. Now it's important to look to the future and see the positive.

However, to its credit, Yahoo is no longer standing still. The first step has already been taken by hiring a new CEO, Marissa Mayer, a former Google engineer. All eyes are on her to see how she will go about waking the sleeping giant. In addition to these changes, Yahoo has embraced corporate governance by adding ex-Paypal employees to the board. Yahoo has been notably left behind in mobile applications, but it is now rising startlingly via its Android mail app. The mail app is also available in Windows 8 mobile and iOS.

In the first quarter under the leadership of the new CEO, Yahoo recorded a 2% increase in revenues, which was roughly in-line with expectations. The sale of Alibaba shares for $7.6 billion also removes a major headwind in a competitive Chinese market. And, since Yahoo Sports is still trendy, Yahoo has entered into an agreement with NBC. The agreement allows Yahoo to have access to NBC’s live streaming. The two businesses also plan to partner on advertisement sales. The two companies will, however, have different newsrooms and independent editorial control of their separate content.

The question going forward is whether Yahoo merits its current premium forward multiple of 16.9x versus Google's 15.9x. Yahoo is forecasted for a 11.7% annual growth rate over the next five years. Assuming expectations are met, 2016 EPS will come out to $1.60. At a multiple of 17x, this translates to a future stock value of $27.20. This only provides for 7.9% average annual returns (different than the geometric average, which accounts for the limited impact of appreciation following years of depreciation). Unless you expect the multiple to expand, it's hard to justify outperformance in the near-term where earnings trends are more certain.


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