Tech

Tim Culpan is a technology columnist for Bloomberg Gadfly. He previously covered technology for Bloomberg News.

Slowing revenue and falling profit don't seem like great conditions under which to pursue an initial public offering. They certainly wouldn't lend themselves to hopes of a valuation 50-times-earnings valuation.

Welcome to Sogou Inc.

Sohu.com Inc.'s search engine business lodged paperwork last week for a New York listing of American depositary receipts. Nestled in the filing are some basic financial numbers that allow potential investors a first glimpse of what's really on offer.

Seems Sluggish
Sogou's monthly active user growth has slowed
Source: Sogou

In January, Sogou Chief Executive Officer Wang Xiaochuan said the spinoff from Sohu may be valued at $4 billion to $5 billion. He told David Ramli of Bloomberg News that growing mistrust in rival search provider Baidu Inc. would help drive his business.

Check the Engine
Sogou's search revenue growth has slowed significantly
Source: Sogou

That's quite a stretch. China's leading search provider certainly suffered from setbacks last year as users and regulators cried foul over a series of medical advertisements. But data from Sogou's filing show that monthly active user and revenue growth are both slowing, while operating profit is also going in the wrong direction.

Margin Mismatch
While Sogou's gross profit has inched up, operating profit has declined
Source: Sogou

Even bottom-line growth looks weak. Six-month net earnings for the period through June climbed 41 percent, according to Sogou's filing. At that same growth rate, full-year net would come in at around $79 million, a figure still 20 percent below 2015 takings. It's important to note the relatively robust growth in the first half came from a lack of one-off items the period prior. Operating profit for the six months ended June 30 was down 27 percent from a year earlier. 

Assuming Wang is still aiming for the lower end of the valuation he spoke of in January, he's going to need to convince investors that slowing revenue and declining operating profit justify a 50-times earnings multiple. Baidu currently trades at 37 times estimated 2017 earnings, and that's with analysts forecasting bottom-line growth of 19 percent this year and 32 percent next. Qihoo 360 Technology Co. traded at a price-earnings ratio of 31.8 before getting bought at an equity value of around 53 times last year.

Don't Look
Growth in Chinese search engine traffic is weak, and Baidu's dominance remains
Source: Bloomberg Intelligence, iResearch
Note: Data are for total visits to that search engine during the month.

After failing to put much of a dent in Baidu's market share, Sogou is now turning to social media giant Tencent Holdings Ltd., a major shareholder, to ignite growth. This month, Sogou started a trial that integrates its search engine into Tencent's WeChat messenger service.

It's highly possible this will boost usage for Sogou, but it's too early to be sure what the scale of such growth would be, or how much it will actually help the bottom line. Until then, Sogou and its shareholders need to keep up the profit search if they hope to justify any lofty valuation.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The transaction closed in July 2016, but was announced in June 2015.

To contact the author of this story:
Tim Culpan in Taipei at tculpan1@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net