Is It Time to Sell This Chinese Tech Company?

On Jan. 24, the Chinese government finally admitted it: It doesn't like Qihoo (NYSE: QIHU  ) .

In its official warning, Beijing listed six "acts of unfair competition" that the company must stop, or it might face sanctions or even a shut down. Although that may seem unlikely, Qihoo has hurt the whole Chinese tech economy more than any other company in recent memory. Here's why the government stepped in, and what it means for Qihoo's future as a business and investment.

6 "Acts of Unfair Competition"
The Chinese government dealt a huge blow to Qihoo. By warning that it must stop its "acts of unfair competition" in the desktop browser space, the government reprimanded Qihoo for abusing its power as an anti-virus security suite. Here are the six tactics that the government denounces:

  1. Making its security suite difficult to uninstall.
  2. Preventing users from installing competitors' software by noting (fake) incompatibility.
  3. Warning users that their non-Qihoo browser is unsafe.
  4. Tricking users to install Qihoo's 360 Browser through default settings.
  5. Forcing security updates to change users' browser and homepage settings.
  6. Tricking users into downloading the 360 Browser as an official patch from Microsoft (NASDAQ: MSFT  ) .

As if out of the twilight zone, the Chinese government warning mirrored last year's complaints by Digital Due Diligence -- an American firm! Of course, I doubt Beijing really meant to acknowledge an American perspective. Rather, the pro-domestic-business government was saying that Qihoo really pushed the limits. And it better stop soon, or else Beijing might step in. At that point, who knows? China might shut down Qihoo.

Could this be the end of Qihoo?
To be honest, I'm hard-pressed to think of a case where the Chinese government has shut down a whole corporation. And I doubt that the government would do something like that; Qihoo has done wonders for China.

First off, Qihoo search has crushed Google in China. Since Qihoo's foray into the space last summer, Google's search market share dropped from 16.2% to 5%; in the process, Qihoo captured 10.4% and the overall market share of Chinese search companies has increased, too.

Qihoo has also dented Microsoft's dominance in the browser space, according to iResearch China. Right now, roughly 300 million Chinese users have Qihoo's 360 Browser (though how often it's used is debatable). How? Qihoo just took Internet Explorer's logo and made it green, thereby tricking users to think the 360 Browser was from Microsoft. Although Beijing's new warning may put an end to this, the government hasn't talked about the situation since Qihoo stole Microsoft's intellectual property over a year ago. All in all, the whole ordeal shows that China will let its domestic companies run amok even if you have cooperated with Chinese Internet rules and let the government monitor, say, Skype calls. At the end of the day, China is domestic-first.

And that's the crux of the problem: Qihoo is hurting Chinese tech companies, too. The warning detailed that the browser deemed "unsafe" by Qihoo was that of Sohu's Sogou (NASDAQ: SOHU  ) . Now, it's unlikely that Qihoo only attacked Sohu. The company probably did the same with Internet Explorer, but Sohu was explicitly pointed out because it's Chinese.

If Qihoo doesn't cease and desist from hurting other Chinese tech players, I'm not sure what might happen. But, there is a first time for everything and investors should be wary for any signs that China may shut down Qihoo and put them in the red.

Qihoo's probable future
More likely, QIhoo will heed Beijing's warnings and curtail its "acts of unfair competition." What company wouldn't when face-to-face with Beijing?

All in all, preventing the company from its reviled cross-marketing tactics will stretch Qihoo thin.

For at least a year now, Qihoo simply tricked people into using its browser. By putting so much effort into these "unfair" tactics, it's doubtful whether or not any of its products are made with quality and real effort.

Moreover, the antivirus maker turned browser maker has moved into search and maps in just a few short months. With so many new verticals, it's doubtful whether this $8 billion market cap company can really take on $34 billion Baidu (NASDAQ: BIDU  ) . So far, Baidu has released several versions of its mobile operating system and several smartphones.

Tired of Qihoo's taunts, Baidu also went on the attack. By launching "Baidu PC Faster" in January, the company signaled that it would take on Qihoo in its own game: desktop security. And by releasing the software suite in Thai and English, Baidu is putting the pressure on Qihoo to compete internationally, too.

With so many areas to invest in and its main marketing strategy gone, Qihoo really has its work cut out for it.

China's warning should be your sign to divest
Qihoo is behind the times. Although the company's "unfair" practices have worked in the past, the company needs to grow up. Now that the tech landscape seems to be dominated by domestic players, Qihoo can't count on Beijing to support it no matter the situation.

This warning should be a wake-up call. Now that it's competing more heavily against domestic players, Qihoo needs to step up its product quality and really identify what its strategy is for growth because right now it's hard to see Qihoo become the "Google of China." Baidu has been around for far too long and may be successful in preventing Qihoo from growing.

Moreover, refocusing a company is no easy task. And that's why I expect Qihoo's $30 share price (at a P/E of 80) to take a huge hit. Baidu, on the other hand, can continue to invest where it already has as the company is best positioned to capitalize on China's huge (mobile) market. And now that Baidu  is trading at a P/E of 21, its price is far more reasonable than Qihoo's. If you want to learn more about the dominant Chinese search provider's strengths and weaknesses, then you should check out our brand-new premium report where we detail the bear and bull cases for Baidu. Just click here to access it now.


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