Sohu.com(NASDAQ:SOHU), a leading web portal and online games provider has released its second quarter results on 27 July 2009, revealing another quarter of decreasing net income despite high revenues. Sohu experienced a 9.8% increase in total revenues since last quarter, with an 11.6% increase in brand advertising revenues from 39.07m to 43.62m, and an 8.1% increase in online game revenues.
Yet, net income fell by 24.8% from 44.59m to 33.53m, making this the second consecutive quarter of negative net income growth. This fall is attributable to the increase in sales and marketing costs, as well as a rise in salaries and share based compensation expenses. Total operating expenses have increased from 38.1m in first quarter to 49.78m in second quarter.
As a result, earnings per share dropped 24.8% to 0.88 in second quarter, after a 20.9% decrease in EPS from 1.48 to 1.17 in first quarter 2009.
The graph below shows a comparison of quarterly total revenues in the last two years. Although total revenues experienced a growth rate of approximately 24% in 2007 and the first half of 2008, growth has slowed in the last 3 quarters with total revenues fluctuating around $120,000. Online games revenue has been growing steadily in the last six quarters while brand advertising revenue has experienced some negative growth in the previous two quarters, but increased by 2.43% in second quarter.
Sohu’s direct competitors are Sina (NASDAQ:SINA) and Baidu. Baidu (NASDAQ:BIDU) is a Chinese internet search provider that offers a range of services including web search, news, MP3, images, videos, internet TV, Anti virus software, and personalized homepages. It operates primarily in China and Japan. Baidu’s second quarter 2009 total revenue was $160.7 million, an increase of 36.7% from second quarter 2008, and net income was $56.1 million, which is a 44.6% increase from second quarter 2008.
Sina is an internet search provider that offers online advertising and mobile services as well as a community blog and messaging platform. Sina reported first quarter total revenues of $71.3m which was a 3.5% increase from the corresponding quarter in 2008, and a 23.7% decrease from total revenues in last quarter 2008.
Other competitors who compete with Sohu as an internet portal include NetEase, PConline and Soufun, and those who compete with Sohu as a search engine include Google, Yahoo! China, and Soso. Competitors for the online games also include Shanda, NetEase, Giant Interactive and Tencent.
Other changes in financial statements
Cash position: Sohu has a net increase in cash from 122.7m in 2007 to 314.4m in 2008. Net cash provided by operating activities has increased from 91.4m to 218.3m over 2008. This significant increase operating activities cash flow is a result of greater net income generated in 2008.
Balance Sheet: As at the end of 2008, Sohu remains debt-free. The company has current liabilities totaling 130.7m and other commitments and contingencies totaling 5.1m.
Through their sponsorship of the 2007 Beijing Olympics, Sohu has been able to increase their brand awareness and attract new users to their internet portal and online games. Many of these users during the Olympic period have remained with Sohu and this has contributed to the increased total revenues over the last six quarters.
Sohu’s position in the Massively Multiplayer Online Role-playing Game (MMORPG) was further strengthened by Changyou.com’s successful initial public offering (IPO) of American depositary shares on Nasdaq. Sohu remains as Changyou’s majority shareholder, with approximately 68.5% equity interest.
Sohu relies heavily on its Massively Multiplayer Online Role-playing Games (MMORPG), in particular Tian Long Ba Bu, for a significant portion of its total revenues. In second quarter 2009, revenue from online games totaled 66.6m, which constituted approximately 52% of Sohu’s total revenue. Thus, any decrease in the popularity of this game could be detrimental to Sohu’s revenues. The company faces the challenge of maintaining popularity of the games through improvement and upgrades.
Online brand advertising also contributes significantly to Sohu’s total revenues. Online advertising is a fairly new market which still involves many uncertainties and is subject to changes in government policies. Sohu’s reliance on online brand advertising may have adverse effects on revenues if demand for this market falls.
Sohu is seeking opportunities to expand their online game business through newly developed games and further licensing opportunities. Sohu’s subsidiary, Changyou has scheduled to begin open beta testing of the in-house developed Duke of Mount Deer, and the licensed Immortal Faith and Legend of the Ancient World, in 2009 and 2010. Sohu is also evaluating licensing opportunities to launch TLBB in Malaysia and Singapore.
A significant threat to Sohu is the intense competition faced by both the advertising and online game business due to the lack of substantial barriers of entry into the internet market. These competitors compete with Sohu on the basis of customer base, products, branding, and technological advancements. Furthermore, Sohu’s position in the market may be jeopardized by the emergence of new competitors or formation of new alliances among competitors.
As Sohu relies on advertising agencies to distribute its brand advertising services, the consolidation of Chinese advertising agencies may pose a threat to Sohu’s bargaining power with the large advertising agencies. The large advertising agencies are currently seeking to consolidate in the market, and this may increase their ability to demand higher sales rebates.