Which of These 4 Chinese Internet Companies Are a Post-Earnings Buy?

Chinese Internet companies Sohu.com (NASDAQ: SOHU  ) , Changyou.com (NASDAQ: CYOU  ) , Ctrip.com (NASDAQ: CTRP  ) , and YY (NASDAQ: YY  ) have all fallen lower after reporting third-quarter earnings. However, in many cases, the initial performance is not a reflection of fundamentals, but rather mass-market reaction, or even sentiment toward a particular sector. With that said, which, if any, of these companies might be a post-earnings buy?

First, what are these companies?
Sohu is a diversified online media, search, and gaming company with many subsidiaries, almost like Yahoo!.

Changyou is one of Sohu's subsidiaries, but is also traded as an individual company; it is a leading Chinese developer of online games -- think Zynga.

Ctrip is China's leading travel agency with the country's largest network, essentially the Expedia of China.

YY.com is a social media platform, but unlike anything in the U.S. It offers a balance of online group activities through voice, text, and video. Essentially, YY is YouTube/Zynga meets Facebook.

Clearly, much of the upside with Chinese Internet companies lies in the fact that many resemble popular U.S. companies. Furthermore, China is a massive country, with a population many times greater than the U.S., but with an Internet that is still emerging. Thus, many believe that such Internet-based companies could grow to become massive corporations in time.

What did we see this last quarter?
Now, looking at the quarterly performances of each company; let's assess how each performed.

In the third quarter, Sohu saw revenue of $368 million, or year-over-year growth of 29%. The performance was above consensus, but the company's EPS and guidance was far below expectations. The company gave no real explanation, but a look at Sohu's operational expenditure (OPEX) -- a 53% rise -- might explain the weakness in EPS -- revenue growth should outperform OPEX in order for margins to rise.

Also, aiding in Sohu's fundamental declines might be its subsidiary Changyou. The company's revenue, EPS, and guidance followed the same pattern as Sohu; its EPS outlook is what disappointed Wall Street. Changyou now expects EPS between $0.34 and $0.41 for the fourth quarter, versus expectations of $1.39. Much like Sohu, no excuse was given, but most analysts believe the weakness is due to its marketing efforts. Still, 10% revenue growth isn't much to be excited about in this sector.

Ctrip saw revenue growth of 31% year over year to $252 million, beating estimates on both the top and bottom line. The company's gross margin of 75% did decline 100 basis points year over year as R&D outpaced revenue growth. However, hotel reservation and packaged tour revenue growth all showed an acceleration over the prior quarter. Yet, the company's revenue growth guidance of 20% to 25% shows a deceleration. Hence, like its peers, there were positives and negatives.

Lastly is YY, a company that significantly beat on both the top and bottom line with revenue growth of 113% year over year. The company continues to show diversification within its business, but now sees over 78% of its revenue from music services and online gaming, both of which are significantly outperforming overall sales growth. Moreover, guidance was substantially higher than estimates, and if there was anything negative to be found, it's that gross margins did decline slightly.

Which is best?
All four of these Chinese Internet-based stocks saw sizable losses following earnings, but with what we know, are any presenting a good buying opportunity?

With Sohu, you get a diversified company trading at 31 times next year's earnings. The company has solid growth and might make a solid long-term investment. However, there is the overhang of Changyou and its struggling business, thus suggesting that Changyou is in no way a good value investment.

Ctrip continues to see solid growth but at 41 times next year's earnings, it might be a bit pricey, especially considering its light guidance.

This leaves YY, a company that I believe is without question the strongest of the bunch. It trades at 27 times next year's earnings, which isn't too expensive, and for that price you get a company with 100% plus growth.

Moreover, considering the company's two largest segments, music services and online gaming, are growing at 161% and 84% year-over-year, respectively, there is reason to be optimistic of its long-term performance. As a result, I'd use the 11% pullback in shares of YY following earnings as a value-presenting catalyst and consider it best-in-class.

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  • Report this Comment On November 07, 2013, at 11:18 AM, Raphael1990 wrote:

    CYOU is nothing like Zynga. If anything it is more like ATVI.

    Changyou has revenue growth of around 20% per year. TTM PE ratio is less than 5(!!). They have little debt and half their market cap is in cash.

    The low earnings guidance(notice the strong revenue guidance) is not because of a weak business but because of marketing campaign expenses for their 2014 product lineup. Even with those expenses the company has - judging by analyst estimates - a forward PE Ratio of less than 10 and the potential growth acceleration is significant. Or if it doesnt work out: Just cut the expenses to the old level and go back to printing money for shareholders (Market cap 1.5 billion, FCF2012 300 million).

    Disclosure: I am a shareholder and I am sceptical about this aggressive initiative, but after deliberating about sell/hold/buy more and looking at the facts I cant really believe that this company is not a good buy here. There is a lot of uncertainty but your are paid so dearly to take it.

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