Sohu Turns to Small Business as Losses Mount

  • ADRs have plunged 19% this year after 7.5% gain in 2015
  • CEO Charles Zhang plans to increase 20% equity stake Inc., the Chinese Web portal that has shed almost a fifth of its value in 2016, is shifting its focus to small and medium enterprises as the nation’s economy slows and analysts forecast a third consecutive annual loss, according to Chief Executive Officer Charles Zhang.

The stock, which gained 7.5 percent in 2015, has tumbled 19 percent in New York this year amid a broad selloff in Chinese stocks as the economy expands at the slowest pace in 25 years. Zhang, who in December said he planned to pay as much as $600 million to increase his 20 percent stake, said the focus on so-called SMEs, which contributed 20 percent of media ad revenue in the fourth quarter, will help offset the macroeconomic impact as smaller companies cut spending less than their larger counterparts.

“That’s why our media and video portals in the future targeting SMEs would be resilient to the macro situation,” he said in a phone interview from Beijing. “We believe that structure of advertising is healthier.”

Sohu will also implement an ad-targeting system akin to Google Inc.’s to its video business and ramp up spending on its media platform, according to Zhang. The company’s big push into digital media -- where it acquires licensed content and provides original shows like Netflix, and streams professionally produced content like Youtube -- may crimp its profitability especially when bigger players such as Alibaba Group Holding Ltd.’s Youku Tudou are already competing for content and user engagement.

Original Content

“We need to spend enough to stay in first tier so that our streaming businesses can pick up. It’s important because in the long term, it will create stickiness within the community,” Zhang said.

While management is hopeful to produce at least 20 original dramas this year, analysts are less excited about the company’s ability to create blockbusters.

“Ideally the strategy of original content can generate money, but Chinese consumers tend to follow big stars, which makes content expensive and attracts bidding from other deep-pocketed players,” said Henry Guo, an analyst at Summit Research Partners, who has hold ratings for both Sohu and its online gaming subsidiary, Ltd.

Beijing-based Sohu is also playing catchup with Baidu Inc. and Tencent Holdings Ltd., which are investing aggressively into other services for China’s 594 million mobile users, ranging from food delivery to movie tickets booking. Sohu said earlier this month it expects to post an adjusted loss between 40 and 65 cents a share for the first quarter this year, compared with an average estimate of a loss of 44 cents a share among analysts surveyed by Bloomberg at the time.

Stock Recommendations

Analysts have lowered their average earnings-per-share estimates for the current fiscal year to a loss of 50 cents from a profit of 69 cents. That’s the biggest reduction in the past four weeks among U.S.-traded Chinese companies, according to data compiled by Bloomberg. They’ve also been reducing ratings. The stock has the least buys since 2006 and the third-lowest consensus recommendation among 11 global peers.

Sohu’s mobile strategy has yet to gain momentum, according to Guo. “While user traffic is migrating from PC to mobile, the company’s mobile game business is lagging behind competitors like Tencent and NetEase,” he said.

The company will not roll out new mobile games in the next two quarters amid mounting concern that a shortening life span of products in that category is eroding profitability. Changyou is “setting the bar high for new games in the pipeline, putting pressure on our short-term revenue over the next two to three quarters,” Chief Financial Officer Jasmine Zhou said in a prepared statement after the fourth quarter results.

Heroes of the Sword

Changyou, whose gaming titles include Tian Lung Ba Bu and Heroes of the Sword, declined 25 percent in revenue in the fourth quarter compared with the same period last year, according to the conference call. Zhang said in an interview he is hopeful that the TLBB game would be revived as the company redevelops the version for mobile users and injects cash for the company by year-end.

While app downloads grew, the trend “may not be big enough to bring growth to the company’s mobile game revenue,” T.H. Capital Founder Tian Hou wrote in a research note on Jan. 27. Changyou is one of the worst performing American depository receipts this year, tumbling 30 percent in New York. Sohu rose 4.8 percent to $46.34 on Tuesday in New York while Changyou added 6.8 percent to $17.36.

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