Why SOHU is the best buy in the China Internet Space

 YOKU acquires TUDO:  Why isn't SOHU worth $90?

YOKU's acquisition of competitor TUDO yesterday represents a strong move to consolidate online video in China.  Considering the current market, there were just three impact players:  YOKU, TUDO and SOHU …. and now there are two.  The market reaction to the transaction, including today's substantial follow-through up-bid in both the acquirer and the acquired, means that the market is valuing video in China as "the next big thing".   If the market was saying "YOKU overpaid", YOKU would have sold off, but instead it is rallying further. 

Looking at December's figures, which are representative of trends in the second half of 2011, we see:

December 2011	Video Websites,  Total Minutes, millions	Total Page Views, millions
YOKU TV	1,801	2,142
TUDO Sites	1,405	2,097
SOHU TV	2,445	2,155
Next 5 competitors combined	1,738	2,256

Data source JP Morgan

These numbers validate the attractiveness of SOHU's content, demonstrating stickiness by attracting viewers to view more minutes per page view than its competitors.

Yesterday's purchase of TUDO for appx $40 a share in YOKU stock sent both YOKU and TUDO soaring, validating a purchase price north of 1.5 Billion USD.  The case for SOHU Video being worth more is obvious.  

SOHU TV is not an afterthought.   It has been carefully assembled, and streams some of China's highest quality content from Sony, Disney and MGM amongst others.  As the CEO stated on their last conference call, they stream 21 of China's top 30 prime time dramas.  All this has caused their viewer metrics to have grown 250% to 300% since Q1 2011. 

SOHU is an integrated internet operator, with strong positions in games, streaming video, search, and a leading portal.  Its games business comes via its 63% ownership of publicly traded Changyou, a leading online games vendor in China.  Sogou's Pinyin search has demonstrated genuine popularity with users, and is steadily gaining market share in a sector written off to domination by "winner take all" dynamics.

We rate SOHU's business development strategies as coherent and credible.   

Taking a "sum of the parts look" at SOHU's enterprise value,  JP Morgan does a conservative and credible job of valuing search, portal and games components.  But given what we now know about the enterprise value of video, we see SOHU north of $90 a share.   

Segment	Value (mil USD)	Comment
SOGU	200	Search, gaining market share, in a sector written off as impossible
Games — CYOU	1,000	Leading player in the space, DD Tank
Portal	700	Conservative in relation to SINA and others
Video	1,200	Pegged by YOKU TUDO transaction
Cash	500	In addition to CYOU cash position
Sum of parts	3,600	Conservative Valuation estimate
Shares o/s	38.76	Million shares
Valuation p/s	$93.00

We couldn't help noticing that even iResearch, in a recent report, measures Sohu's weekly unique visitors 50% higher than Qihoo 360.  If SOHU carried the same market cap as Qihoo, its portal would be valued at $3 billion, and SOHU's per share valuation would be $145.00. 

Company Category Weekly UVs(M) %Change Tencent Portal 276.43 + 4.47% Baidu Search 266.81 + 4.64% Sina Portal 188.46 + 4.16% Sohu Portal 181.83 + 3.84% NetEase Portal 129.20 + 10.24% Qihoo 360 Navigation 116.25 - 2.83% Youku Online Video 131.27 - 0.11% Company Category Weekly UVs(M) %Change Renren SNS 61.31 + 9.96% Dangdang E-commerce 4.40 + 6.42% Ctrip Travel 37.80 + 8.40% 58.com  Classified Ads 20.98 + 4.37% 360buy E-commerce 16.67 + 6.64% Lashou Group Buying 7.38 + 3.43% Vancl E-commerce 8.15 + 0.53% Source: iUserTracker, professional user behavior monitor software with more than 200,000 Internet users in China

No, we don't think SOHU is worth 145, but it demonstrates how ludicrous Qihoo's valuation is at a $23 share price.

Cautious Investing to All.