The Two Sides of the Sohu.com's Changyou.com IPO (SOHU, CYOU)

We may actually get an IPO as soon as early next week.  This recent filing from Sohu.com Inc. (NASDAQ: SOHU) for the proposed spin-off of Changyou.com is supposed to trade under the ticker of “CYOU” on NASDAQ.  What will be more interesting to see than the actual IPO is whether its backers win or whether the doubters win.  An amended filing after the close today shows additional data showing a $14 to $16 price range.

There are some solid merits behind this company being spun out.  Changyou.com has a very wide customer base with a very popular product.  MMORPG’s video game dominance in China can be a very profitable arena.  Changyou operates two MMORPG’s, TLBB, and Blade Online. For the three months ended December 31, 2008, Changyou.com had approximately 1.8 million active paying accounts, which game points are utilized for the purchase of virtual items at least once during a given period, for TLBB and approximately 159,000 active paying accounts for BO.

Changyou.com’s revenues grew from $42.1 million in 2007 to $201.8 million in 2008, and its net income grew from $5.3 million to $108.0 million during the same period. For the year ended December 31, 2008, 93.6% of total revenue was attributable to TLBB.

But there is a flip-side to this as well.  No one wants to hear the term “tracking stock” any longer.  Yet that is sort of how this feels.  The spin-off is a partial spin-off.  The amended filing tonight shows that 7.5 million ADS’s are being sold, with half of the shares being sold for proceeds to go to Changyou.com itself and the other half going to Sohu.com.  There are some reports that the Changyou.com unit raised some $70 to $80 million in recent weeks in Hong Kong.

Sohu’s equity interest in Changyou will be reduced from about 84.2% down to about 70.7%.  The reason for noting the “tracking stock” similarity is that Sohu will apparently continue to consolidate all of Changyou.com’s revenues and expenses and there will be a provision for minority interests.  Sohu.com will maintain 81.5% of the voting power via A and B shares assuming that the overallotment is not exercised.  After the offering there will be 15 million Class A shares outstanding and 87.5 million Class B shares outstanding.

The expected price range is still $14 to $16 from the original filing and the lead underwriters are Credit Suisse and Merrill Lynch (B of A); others listed in the underwriting syndicate are Citi and Susquehanna.  We were told by a contact in the syndicate that this is set to price March 30 for trade on March 31, but we want to remind that this could price early, late, or not even at all.  Despite the market rally of late, the recent trends are still that of caution and the IPO’s have not yert returned.

We spoke to a contact in one of the firms and he noted that customers are turning in rather large orders to see what they can get for a trade.  The problem outside is that some are calling it confusing and some do not like the structure and current prospects.  In just the last week, Sohu.com has seen its ratings downgraded at Citigroup, Pali, Oppenheimer, Stern Agee, and a target cut at RBC.

There is some interest here in this deal, but it is not without critics.

Jon C. Ogg
March 25, 2009