Sohu Surges on Sogou's Special Dividend

Zacks Equity Research

Shares of Inc (SOHU) surged 12.35% ($8.37) to close at $76.13 on Sep 18, after the Internet service provider announced that its subsidiary Sogou paid a special dividend of $301.0 million.

Sogou paid the special dividend from a $448.0 million investment it received from Tencent. Sohu Search received $161.2 million, while other preferred shareholders, China Web and Photon, received dividend of $0.96 million and $0.43 million, respectively.

Most recently, Sohu and Tencent Holdings Limited announced a partnership, under which Tencent invested $448.0 million in cash to acquire a 36.5% stake in Sogou (Sohu’s search business), which can be increased to 40.0% in the future.

Tencent’s Soso search related business and certain other assets will be merged with Sogou. Sohu will hold the controlling interest in Sogou, which will continue to operate as a subsidiary of Sohu.

The Sohu-Tencent partnership will improve Sogou’s competitive position against market leader Baidu Inc. (BIDU) and Qihoo 360 Technologies (QIHU), which ranks second in both PC and mobile search market going forward.

Tencent’s strong mobile user base will boost Sohu’s mobile search traffic. Sogou will become the default search engine for Tencent’s mobile browser. Tencent will also promote Sogou’s mobile input method on mobile platforms such as mobile QQ and WeChat.

The partnership will boost Sohu’s user base and market share, which will further improve monetization efficiencies over the long term. Sohu expects Sogou to grow at a faster rate in 2014 based on the synergies from this partnership.

We believe that Tencent’s investment will improve Sohu’s liquidity, which will help it to invest further on developing video and other services. We believe that Sohu’s innovative product pipeline and monetization efforts by selling mobile ads on video for Apple’s (AAPL) iPad will drive top-line growth going forward.

However, continuing investments in product development will keep margins under pressure in the near term. Despite higher spending and the recent partnership, we believe that market share gain will be difficult in the near term due to stiff competition in most of its operating markets.

Currently, Sohu has a Zacks Rank #5 (Strong Sell).

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