Qihoo 360 Technology: Do Costs Really Matter?

Qihoo 360 Technology (NYSE: QIHU  ) shares fell more than 4% on Monday after Nomura cut its price target from $125 to $113. While Qihoo 360's stock is still significantly lower than Nomura's target, the firm was quite bearish in its reasoning for the cut. If we look at the core argument -- expenses -- how does Qihoo 360 compare to other growth companies in the security space like Cheetah Mobile  (NYSE: CMCM  ) and FireEye (NASDAQ: FEYE  ) , and are expenses a significant threat to long-term shareholders?

What's Nomura saying?
Nomura says that despite Qihoo 360 beating estimates, its fundamentals were inflated by a $28 million one-time gain. Qihoo 360 beat EPS expectations by $0.20, or $24.5 million, and topped the revenue consensus by $36.9 million with $265.1 million. The quarter appears solid.

Yet, Nomura's outlook is not based solely on one quarter, but rather a trend of rising expenses, causing the firm to cut its 2014 and 2015 EPS estimates by 10% and 13%, respectively. With that said, costs for online-based companies are always a concern. Are Qihoo 360's current operating costs a concern looking ahead?

A common connection
Qihoo 360, Cheetah Mobile, and FireEye all operate in the security industry, albeit providing different types of services. FireEye sells appliances that prevent advanced persistent threats, or APTs, which give warning of threats, but do not actually eliminate or prevent the problem.

Qihoo 360 develops applications and platforms for security and optimal performance in China on PCs and in mobile. In its last quarter, the company reported monthly active users, or MAUs, of 479 million across all PC applications. But, on its core smartphone application, 360 Mobile Safe, the company reported 538 million users.

Cheetah Mobile is a smaller version of Qihoo 360, one that focuses on the mobile space. According to its F-1 filing, Cheetah Mobile has 362 million MAUs across all applications with its file-cleaning, memory-boosting  security application, Clean Master, accounting for 139.9 MAUs.

How does Qihoo 360 compare?
In this particular conversation, the biggest concern is costs, whether Qihoo 360's spending is acceptable to Wall Street and whether it will limit the stock's gains. Perhaps the best way to illustrate how Qihoo 360 compares to its peers is to find the amount of money that each company spends to produce one dollar in revenue, which can be found by comparing revenue to operating expenses.

Keep in mind, we're using data from FireEye and Qihoo 360's last period, as it was the latter's quarter that came into question, while Cheetah Mobile's yearly data from its F-1 is being used in the comparison.

Company

Revenue

Operating Expenses

Cost Per Dollar

Qihoo 360

$265.1 million

$225.5 million

$0.85

FireEye

$74 million

$181.2 million

$2.44

Cheetah Mobile

$123.8 million

$85.4 million

$0.69

When we look at the operating efficiencies of these three companies, FireEye's spending sits at the bottom. But Nomura might have a point with Qihoo 360's rising costs. Despite higher operating costs as a percentage of revenue, Qihoo 360's profit margin is nearly twice that of Cheetah Mobile at 17.3%, which might not be sustainable.

Cheetah Mobile has higher costs of revenue, driving its gross profit lower, and it has not had the allowances noted by Nomura, nor has Cheetah had other significant cash flow from financing activities. Therefore, when you look beneath the revenue and net income, it's clear that Qihoo 360 might be spending too much, or at least as it compares to Cheetah.

Final thoughts
With that said, spending $0.85 to create a dollar is not necessarily a bad thing when a company's growing at 100%-plus annually. Moreover, Qihoo 360 does have an enormous search business that it's just now starting to monetize , and is significantly cheaper than Cheetah Mobile at 13 versus 20 times sales, respectively.

As a result, Nomura might be correct in its analysis that costs are something to monitor. But in the larger scheme of Qihoo 360's business, $0.85 per dollar is hardly a significant problem.

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