Is Cheetah Mobile Following in the Footsteps of Qihoo 360?

Before you appoint Cheetah Mobile the next Qihoo 360, there's one thing you might want to consider.

Jun 12, 2014 at 12:33PM

Qihoo 360 (NYSE:QIHU) and Cheetah Mobile (NYSE:CMCM) operate in the same security application industry, with Qihoo being the market leader. Cheetah Mobile became a public company in May, and already its valuation has soared 45%, thus following Qihoo's lead. However, given Qihoo's growing competition with Baidu (NASDAQ:BIDU) in search, and this added element, should investors be quick to jump on Cheetah's bandwagon?

CMCM Chart

Source: CMCM data by YCharts

What are these companies?
Qihoo 360 and Cheetah Mobile are security companies, offering numerous applications to prevent threats and optimize the performance of different devices. While Cheetah operates solely in the mobile space, Qihoo also has a large presence on PCs.

Specifically, Cheetah's Clean Master application for file-cleaning, security, and memory-boosting has well over 150 million monthly active users, or MAUs. In total, Cheetah has 222.5 million MAUs, which represents growth of 33.9% quarter over quarter. Also, in Cheetah's first quarter, revenue grew 131.6% year over year to $50.8 million, and its operating profit margin was 6.1%.

In comparison, Qihoo has a much larger user base, including 479 million users on PCs, and 538 million on its most popular mobile application, Mobile Safe, which grew 13% quarter over quarter. During its last quarter, Qihoo grew revenue 141% to $265 million, and issued guidance far ahead of the Wall Street consensus. ,

Given Qihoo's long-term success and Cheetah's strong initial stock performance as a public company, we can assume that investors are hoping Cheetah will grow to become the next Qihoo. However, Qihoo has something that Cheetah lacks, and it's this edge that might leave Cheetah investors disappointed with the long-term outcome.

The distinguishing difference
Given Cheetah Mobile's foolish growth, it's hard not to be bullish when investors see the near $25 billion company that Qihoo has become. Cheetah is a solid company, as the No. 2 Internet security software provider in the fast-growing Chinese market, where Qihoo is obviously No. 1. However, there is one distinguishing difference between the two companies -- Qihoo's growing search business.

The potential of search
While Qihoo and Cheetah Mobile have various services to create revenue, the majority is earned by referring users to other sites, such as e-commerce juggernaut Alibaba. This has proved to be a highly lucrative model, but Qihoo has recently diversified, using its large user base to enter the Internet search business.


Source: China Internet Watch

Albeit, Qihoo's revenue from its search business has been insignificant to date, as it has yet to implement monetization strategies. However, given Baidu's $5.7 billion in created revenue during the last 12 months, investors can assume that search will eventually become a multi-billion dollar business for Qihoo, which gives Baidu competition and might consequently hurt its margins. 

  Baidu is a $60 billion company and China's market leader in the search industry, controlling 58% of it. However, while the market as a whole continues to grow quickly, Baidu's market share has declined in recent quarters, down from nearly 80% in years passed. The culprit for this lost share has been Qihoo, which owned a 23% share in the fourth quarter, and a 25% share in the first quarter. 

Foolish thoughts
With all things considered, much of Qihoo's 12.6 times sales multiple is tied to the prospects of its search business. This is a segment that Cheetah does not currently possess. Therefore, with near-equal growth, Qihoo's higher margins, and both companies trading at 12 times sales, investors might be best served not looking for the next Qihoo. Instead, Qihoo still looks attractive, as it's far from reaching its full potential.

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Brian Nichols owns shares of Apple. The Motley Fool recommends Apple and Baidu. The Motley Fool owns shares of Apple 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.

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