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Is Baidu's Biggest Rival Finally Getting Its Act Together?

By Leo Sun - Mar 10, 2020 at 12:40PM

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Sogou continues to grow in Baidu’s shadow with a resilient search platform and an expanding voice search ecosystem.

Sogou (SOGO), the Chinese tech company that owns the country's second largest search engine, recently posted its fourth-quarter numbers. Its revenue rose 1% annually to $301 million, missing estimates by $1.8 million.

Its net income rose 33% to $35 million. On a non-GAAP basis, which excludes stock-based compensation and other one-time charges, its net income rose 44% to $39 million, or $0.10 per share -- which beat expectations by a penny.

Sogou's management on stage at an event promoting its AI devices

Image source: Sogou.

For the first quarter, Sogou expects its revenue to dip 1% annually (at the midpoint), topping analysts' expectations for a 6% drop. That guidance was encouraging, since it factored in the coronavirus outbreak and other macro challenges.

As a result, Sogou was one of the few stocks that advanced on March 9 as the broader market plunged on concerns about the coronavirus and plunging oil prices. So, is Sogou, once considered a hapless underdog in China's crowded advertising market, finally getting its act together?

Understanding Sogou's core business

Sogou's search engine controls 21% of China's online search market, according to StatCounter. Baidu (BIDU 1.86%) leads the market with a 69% share.

Tencent, Sogou's largest stakeholder, integrates Sogou's search engine into WeChat, the top mobile messaging platform in China with over 1.15 billion monthly active users, to process the app's internal searches. Sogou also integrates its searches into Microsoft's Bing, which controls less than 2% of China's search market, and the popular question-and-answer site Zhihu. These partnerships helped Sogou remain relevant in Baidu's shadow.

Sogou's Mobile Keyboard, a replacement keyboard for mobile devices, is also the most widely used input method for Chinese characters in China. Sogou subsequently expanded the app to process voice typing and searches. The app's daily active users grew 9% annually to 464 million during the fourth quarter, while daily voice queries rose 54% to over 800 million. Sogou also sells hardware devices, including AI-powered recording devices, to tether more users to its voice search ecosystem.

How fast are its core businesses growing?

Sogou's search and search-related revenue dipped 1% annually to $274.6 million during the quarter. The segment continued to struggle with China's economic slowdown and tough competition from rivals such as Baidu and ByteDance.

An ad for Sogou's C1 Smart Recorder

Image source: Sogou.

Its traffic acquisition costs (TAC) fell 14% annually to $129 million, or 42.8% of its total revenue -- compared to 50.3% in the prior-year quarter. Yet its auction-based pay-for-click services accounted for 88.2% of its search revenue, up from 84.8% a year ago.

Those numbers suggest Sogou isn't aggressively courting advertisers, but they're still consistently buying ads. This indicates that Sogou's core search engine, its ties to WeChat, and its massive voice search ecosystem are all naturally shoring up its defenses against Baidu.

Sogou's "other" revenue rose 26% annually to $26.4 million, thanks to sales of hardware devices such as its AI Smart Recorder C1 and C1 Pro -- which allow users to record memos, transcribe and translate them, and upload them to the cloud.

Expanding margins and improving profitability

In the past, Sogou's high TAC weighed down its margins and resulted in net losses. However, tighter controls over its TAC and the growth of its pay-for-click model boosted its non-GAAP gross margin annually from 37% to 44%. Its non-GAAP operating margin also expanded from 4% to 14%.

Sogou's non-GAAP net income declined 7% for the full year, due to weaker growth in the first half of the year. However, analysts are expecting 28% growth in 2020 -- which is an impressive growth rate for a stock that trades at just 15 times forward earnings.

Is it finally time to buy Sogou?

Sogou's outlook for the first quarter was rosier than Baidu's forecast for a 5% to 13% annual decline in revenue. Sogou's resilient growth and expanding margins also suggest it will thrive when the coronavirus crisis finally ends. Sogou's still a riskier investment than bigger tech companies such as Baidu or Tencent, but I believe this stock -- which is trading 70% below its IPO price -- still has room to run.

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Stocks Mentioned

Sogou Inc. Stock Quote
Sogou Inc.
Microsoft Corporation Stock Quote
Microsoft Corporation
$259.58 (1.07%) $2.75
Baidu, Inc. Stock Quote
Baidu, Inc.
$151.49 (1.86%) $2.76
Tencent Holdings Limited Stock Quote
Tencent Holdings Limited
$45.28 (-0.24%) $0.11

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