Qihoo 360 Earnings Trade Margins for Growth

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Qihoo 360 Technology Co. Ltd. (NYSE: QIHU) reported second-quarter fiscal 2014 results before markets opened Monday. The Chinese Internet and mobile device security products provider reported adjusted earnings per American Depositary Share (ADS) of $0.50 on revenues of $317.9 million. In the year-ago quarter, Qihoo 360 posted earnings per ADS of $0.40 on revenues of $151.7 million. The consensus estimates called for earnings per ADS of $0.46 on revenues of $309.38 million. Every two ADSs represent three Class A ordinary shares.

Over the past 24 months, shares of Qihoo 360 have risen about 300%, compared with a two-year gain of about 60% at Baidu Inc. (NASDAQ: BIDU) and a loss of about 18% at Sina Corp. (NASDAQ: SINA). But growth has tapered off at Qihoo 360, while remaining approximately even at Baidu. In the past 12 months, Qihoo 360 is up 39% and Baidu is up about 55%.

The company claimed 641 million users for its 360 Mobile Safe security product at the end of the first quarter. The company’s CEO also said:

As we maintain our leadership position in key PC-related product categories, we are making a significant transition to the ever more-important mobile Internet market. … A few days ago, our share of Internet search traffic reached over 30% according to third-party data, achieving our year-end target four months ahead of schedule. As we continue to claim higher market share in PC search, we intend to allocate significantly more resources to support product development and market penetration of our mobile search.

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The problem with growth is that it costs money, and Qihoo 360’s non-GAAP net margin fell from 33.6% in the second quarter a year ago to 21.8%. Sequentially non-GAAP net margin fell by a fifth, from 27.7%. In the fourth quarter of 2013, Qihoo 360 reported non-GAAP net margin of 38%. Three consecutive quarters of falling margins will not make investors happy, and shares are very likely to fall in Monday’s trading.

Online advertising revenues grew about 89% to $171.3 million, and value-added services revenue rose 140% to $146.2 million. The gain in services was attributed to strong growth in both PC and mobile games.

Qihoo 360 expects third-quarter revenues to total $360 million to $365 million, nearly double the revenues in the same period a year ago and up around 13% sequentially. The consensus estimates call for earnings per ADS of $0.67 on revenues of $357.39 million.

All eyes, of course, are on the coming initial public offering of Alibaba, which is expected to become a reality next month. Will there be a halo effect from what will certainly be the largest IPO of the year and one of the largest of all time on a U.S. exchange? Will Qihoo 360 and Baidu, Sina and Weibo Corp. (NASDAQ: WB) get a boost? Stay tuned.

Shares were down about 5.7% in premarket trading Monday, at $95.76 in a 52-week range of $72.20 to $124.42. Thomson Reuters had a consensus analysts’ price target of around $135.00 before the results were announced.

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