Qihoo 360's Management Has Zen-Like Focus

Qihoo 360 (UNKNOWN:QIHU.DL) released its fourth-quarter earnings last week. The company saw excellent growth across every business segment, increasing total revenue 115%.

The company is successfully capturing online advertising share from rival Baidu (NASDAQ:BIDU), but Baidu continues to aggressively spend its cash flow on growing its business, particularly on mobile. Meanwhile, the company is feeling more pressure from Alibaba as the e-commerce giant moves into game distribution. Earlier this year, it was speculated that Alibaba may invest in Qihoo 360.

Qihoo's management isn't distracted by what others do. Focus remains on the company's core product first, and management iterated that idea on the most recent earnings call more than once.

Core strengths
During the conference call, analysts noted that there are a few areas of the Chinese Internet economy that are growing rapidly, but Qihoo is notably absent. In particular, they asked about e-commerce and Internet finance.

Both are areas that Baidu has gotten into with its purchase of Nuomi.com from Renren and its own banking products. Additionally, Alibaba, besides being at the head of e-commerce growth in China, is also its leading Internet finance company with its Yu'e Bao product. As of last month, the company had more than 400 billion yuan ($65.4 billion) in deposits.

When asked if Qihoo would get into the market, CEO Hongyi Zhou (translated by CFO Zuoli Xu) said:

We look at this hot spot [Internet finance] as not necessarily the area that we are expert on. And so we still believe any given company should focus on what you're good at. For us, obviously, security is really the core value of the company.

When asked about the potential for the company to get into e-commerce, the response was similar:

E-commerce is a very, very important part of the Chinese Internet ecosystem. But we ... do not have the e-commerce DNA. We want to focus on where we're good at in terms of the other two areas: the advertising -- and in particular search advertising -- the games -- particularly the mobile games.

Instead, Qihoo's management believes it has a lot of work to do to fully monetize those two strengths first.

Management isn't ignoring everything
Although Qihoo is focused more on its strengths than growing into new verticals, that doesn't mean it's completely ignoring the evolving Internet economy in China. Indeed, Zhou was quick to point out that certain aspects of Qihoo's strengths play well with the growth in both Internet finance and e-commerce.

As more and more ... assets keep moving online both on mobile and PC Internet, security becomes [an] even bigger issue. And given our core strength's in that area, we believe we can play a very, very important role even without directly doing the Internet finance.

Today, we have a basic relationship -- or partnership -- with pretty much every single major e-commerce company in China. We intend to keep that kind of relationship growing.

In other words, Qihoo can capitalize on these trends without losing focus from its core strengths in security and online advertising. As e-commerce grows, Qihoo should be able to leverage its traffic into better revenue. Additionally, it can ensure security in online transactions and deposits.

Product first
This year, Baidu plans to spend its way to further revenue growth through things like pre-installed apps and other sales expenditures. When asked if Qihoo plans to follow a similar path, Zhou noted there's a better way for the smaller Qihoo to grow. While he concedes that the company will, to some degree, have to spend money on marketing and pre-install, he believes a product-first approach is better at this time.

We believe the key thing ... is really about innovation and user experience. ... This year, we'll continue to spend significant resources in product development to make our products better, and for that to help us gaining more users across the products portfolio.

This is similar to the sentiment he expressed on the previous quarterly conference call.

If your products haven't reached perfection and then you do it, a lot of the marketing campaign to make the users ... come to your products, eventually they will go. And so for us, we are basically in that perfection process.

It would be an impossible endeavor for Qihoo to try to out-market Baidu. Qihoo ended the year with $1 billion in cash, while Baidu had approximately $6.27 billion on its balance sheet. Baidu's cash flow is significantly higher as well, generating approximately $670 million in cash flow last quarter compared to just $77 million by its smaller competitor.

Focused growth
Qihoo has already taken significant market share; its security software is installed on over 94% of PCs and 70% of mobile devices, its browser is on over 70% of PCs, its app store accounts for 40% of app distribution, and its search share has climbed to about 25% in less than two years.

The next steps are for the company to better monetize its user base and capitalize on applying its strengths to other segments of the Chinese Internet economy. Management won't be distracted by the competition.