Qihoo 360: A 2-Way Investment Play

Qihoo 360 (NYSE: QIHU  ) is known for its anti-virus business, but is quickly growing into a relevant name as a search operator. Currently, this market is dominated by Baidu (NASDAQ: BIDU  ) , a diversified company often compared to Google (NASDAQ: GOOG  ) (NASDAQ: GOOGL  ) , but given Qihoo 360's recent stock losses and its two-headed monster, it might now present a golden investment opportunity.

Qihoo growing in search
Qihoo is a small, but very diversified company. It's known primarily to Wall Street as a Chinese security app vendor, and to a lesser degree for its gaming segment. Furthermore, the company has an enormous user-base; in the fourth quarter, it reported smartphone users of its primary security product reached 467 million, up from 207 million in the year prior.

Qihoo is the undisputed leader of Internet security in China, with its monthly active users representing 70% and 95% of the PC and smartphone market, respectively. Thus, it's no surprise revenue soared 115% to $221 million in its last quarter and that the company carries operating margins of 24% as a well-established leader in a growing market.

However, Qihoo has recently set its aim at a larger market -- online search. This is a space dominated by Baidu, and was responsible for nearly all of its $1.52 billion in first quarter revenue, and 59.1% growth. While Baidu's revenue per advertiser continues to rise, Qihoo has become a real threat in this space.

Last year, Baidu controlled 70% of the search market, but today that share has fallen to 60%. Moreover, in the fourth quarter, Qihoo's share had doubled year-over-year to 23%, and in March, its share reportedly increased to 25%. Therefore, Baidu's fallen share price can likely be attributed to Qihoo's success.

Baidu is not a bad investment
Baidu may be losing share, but China's search market is growing fast, and Baidu is the most developed advertiser in this model. Therefore, its revenue continues to soar. In fact, despite Baidu losing share, analysts still expect revenue growth of 50% and 36.5% for the next two years, respectively. Investors believe much of this growth will come from travel, e-commerce, gaming, and other new segments.

In comparison, U.S. search giant Google is expected to grow revenue by just 10.5% and 17.7% in the same two-year period. Currently, Google trades at 27 times earnings versus a 30 times multiple for Baidu, implying a very small premium for significantly faster growth. Essentially, this signals a discount on shares of Baidu, which suggests that Baidu is not a bad investment amid falling search market share.

Qihoo looks like a good investment
It's important for investors to realize that Qihoo is still in the infancy stage of monetizing its growing search presence. In fact, the company's 115% revenue growth was nearly all created from its security business, as the company has yet to report any exact numbers from search, citing its fundamental impact as being too small right now.

Yet, with a 25% market share, Qihoo's share is 40% of Baidu's, a company that created more than $1.5 billion in quarterly revenue. For long-term investors, this signals that Qihoo's search business could, one day soon, become a major revenue generator, and could produce high margins like Baidu.

Final thoughts
Right now, Qihoo is a security play for investors, but behind the scenes, this company is blowing up the Chinese search market. Granted, neither investors nor analysts know when the company may start to monetize this large presence in search, but conventional wisdom suggests that, when it occurs, the company's revenue will soar to a new level.

Therefore, at 21.5 times forward earnings -- Qihoo has lost one-third of its valuation from 52-week highs -- this stock is rather cheap, especially considering the company's growth. Albeit, as Chinese momentum stocks continue to fall, many for the right reasons, Qihoo remains a company that's simply guilty by association, one where fundamentals support the valuation and losses should be viewed as opportunity.

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