Qihoo's Growing Dominance in China Is a Sign of Better Things to Come

Qihoo 360 Technology (NYSE: QIHU  ) has made rapid progress in the Chinese Internet industry. The company is now providing stiff competition to Baidu (NASDAQ: BIDU  ) , taking away market share and rubbing shoulders with Tencent (NASDAQOTH: TCEHY  ) in the gaming market as well. Looking forward, will Qihoo be able to sustain its terrific performance, or will it end up defeated by bigger peers? 

Qihoo is growing at a very fast pace; in the fourth quarter, revenue increased 115% year-over-year to $221.6 million, comfortably beating analysts' estimate of $209 million. In addition, Qihoo's earnings also increased an eye-popping 218% year-over-year to $0.70 per share, outpacing consensus estimates of $0.43 per share.

Dominance counts
Qihoo's success is a result of the company's concrete steps to strengthen its mobile security and mobile app store products. With its PC-based active users reaching 475 million, Qihoo enjoys a dominant position in the Chinese Internet industry. Moreover, 70% of China's active PC Internet users use Qihoo's PC browser. In addition, Qihoo is the leader in smartphone security in China with 70% market share.

Going forward, Qihoo expects its leading position in Android-based app distribution in China to drive results. Qihoo leads with more than 40% of the market in its bag. Further, the company's search engine is witnessing meaningful traffic gains, having hit a market share of 23% at the end of 2013. 

This is a big achievement for the company since Baidu was the dominant player in the search industry in China at one point of time. Last May, Baidu commanded 70% of the search market in China. However, that metric has decreased to 58% now, according to Chinese research firm CNZZ. Going forward, Qihoo is intent on narrowing the gap with Baidu further by achieving 35% share of the Chinese search market by the end of 2014. In addition, the company has already launched a few mobile search related products to improve its position on this platform as well.

Gaming growth
On the other hand, Qihoo's game platform is also attracting game developers and users in good numbers. Qihoo runs about 800 games on its game platform and is adding subscribers at a decent pace. At the end of the fourth quarter, Qihoo had about 700,000 paying gaming accounts compared to 560,000 in the prior quarter. Going forward, as the Chinese gaming market is expected to grow at a fast rate, Qihoo should see further improvements in this metric.

However, Qihoo has to overcome the giant Tencent in a bid to make its mark on the Chinese gaming industry. Tencent is the biggest game operator in China. In what would come across as a remarkable fact, Tencent is the world's biggest company in terms of game-related revenue, according to research firm Newzoo.

Tencent's QQ Games portal has been a big success, and now the company is extending its reach through its popular WeChat messaging service. The WeChat client also distributes digital games and has 300 million registered users in China. So, Tencent has a strong hold in the Chinese gaming industry, which Qihoo will need to overcome if it is to make meaningful progress in the future.

Takeaway
Conservative investors might now like Qihoo after looking at its trailing P/E of 114, which appears highly overvalued. However, the forward P/E of 23 is quite reasonable and indicates rapid earnings growth. Qihoo has delivered solid earnings growth in the past and, given its growing dominance in the Chinese Internet industry, the streak could very well continue in the future. So, looking at its growth rate, investors should not mind paying a premium for the company.

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