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Sohu's on First

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Investors don't want to have anything to do with (Nasdaq: SOHU  ) this morning.

The Chinese dot-com pioneer fell sharply after posting uninspiring quarterly reports and troublesome guidance for the current quarter.

Revenue did climb a better-than-expected 42% to $246.2 million in the fourth quarter, but that's pretty much where the good news ends.

One-time impairment hits related largely to Sohu's wireless business and the cinema advertising business of its majority-owned (Nasdaq: CYOU  ) gaming arm dropped profitability all the way down to $0.65 a share. Sohu earned $1.07 a share a year earlier, and analysts were banking on net income of $1.24 a share.

Back out the one-time items and stock-based compensation to arrive at the more indicative $1.36 a share, and that still leaves a problematic question to tackle: Why are adjusted earnings only climbing 10% after a 42% top-line surge?

The revenue mix explains part of the slip in margins. Online gaming -- which now accounts for half of Sohu's revenue -- climbed at a 34% clip. Gaming offers higher margins than online advertising, and it's not growing as quickly as Sohu for a change.

Sohu's fastest segments aren't in areas where chunky margins like to party. Sohu runs a thriving online video business. Streaming video is becoming very popular in China, but the two top dogs in this niche -- video site operators (NYSE: YOKU  ) and Tudou (Nasdaq: TUDO  ) -- aren't even profitable. Sohu didn't reveal if it's turning a profit in online video, but even if it is, it's going to be a drag on margins. Advertisers in China still aren't paying the kind of rates that can turn a business model that consists of streaming chunky video files all that profitable.

We also have Sogou. Sohu's search engine is a speedster. It grew its top line by 248% to $23 million this past quarter. Baidu (Nasdaq: BIDU  ) is projected to post an 88% pop in revenue during those same three months. However, Baidu is 30 times larger than Sogou.

Investors probably would have overlooked some of the fourth quarter's rough spots if it wasn't for the frustratingly low guidance. Sohu sees an adjusted profit of $0.50 a share to $0.55 a share for the current quarter, well short of the $1.13 a share that analysts were targeting. Sohu's revenue outlook of $212 million to $225 million is less than the $238.2 million that Wall Street was forecasting.

There is a seasonal dip in online advertising throughout China during the first quarter, but it's never been this sharp a drop-off for Sohu.

Investors are scared, and understandably so.

Thankfully for Sohu, the company isn't going away. Sohu closed out the quarter with no debt and a cash position of $733 million. Sohu's top line is still improving at a heady clip and this morning's drop finds Sohu trading at a trailing earnings multiple in the pre-teens.

Sohu will have to prove that the current quarter's letdown will be a fluke to vindicate the bargain seekers buying in today, but Sohu's strong history in China has earned it that trust.

Baidu has soared 1,513% since I recommended it to Rule Breakers newsletter subscribers six years ago, but now it's time to discover the next Rule-Breaking multibagger. It's a free report. Want it? Get it.

Motley Fool newsletter services have recommended buying shares of and Baidu. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

Read/Post Comments (3) | Recommend This Article (2)

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  • Report this Comment On February 07, 2012, at 2:25 AM, sliderw wrote:

    I clicked on this article solely because of its catchy title.

  • Report this Comment On February 07, 2012, at 1:51 PM, TMFBreakerRick wrote:

    Sliderw, while a "thank you" is in order, I hope the article was in someway enlightening beyond my old school nod to Abbot & Costello that got you here.

  • Report this Comment On February 07, 2012, at 2:44 PM, outoffocus wrote:

    I get it...

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