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Baidu, Qihoo Bets On Mobile Gaming Starting To Pay Off

China's 310 million mobile gamers increased their spending by 247% in 2013, an official Chinese government statistic that has China tech companies scrambling to grab handset gamers.

Qihoo 360 Technology (QIHU), Baidu (BIDU) and others spent heavily in 2013 on new mobile-gaming apps and distribution platforms, efforts that in Q4 showed some early signs of paying off.

"2014 is a critical year for many Internet companies in China," T.H. Capital analyst Tian X. Hou wrote in a Monday research note. "We believe the strong momentum in both mobile and search can continue .. .

Mobile gaming revenue in China is still relatively small when compared with overall gaming revenue, but it's growing at a much higher rate as gamers ditch their PCs for smartphones.

Mobile gaming sales growth is expected to slow in 2014 to 94.2% from 247%, which nonetheless will outpace the 28.9% advance in online gaming overall, according to local research firm iResearch Global.

Tech giant Tencent long has been China's desktop gaming leader, with NetEase (NTES) trailing it. But the mobile gaming landscape doesn't yet seem to be set in stone, say analysts. NetEase, for example, hasn't managed to transfer its success in desktop gaming to mobile gaming.

Much of the money that's being spent on mobile gaming in China is toward building app-distribution platforms.

Qihoo, Baidu App Leaders

Qihoo in Q4 handled about 39% of all mobile-app distribution in Q4, according to Maxim Group analyst Echo He.

Baidu, which last year paid $1.9 billion for app store 91 Wireless Websoft, has about 41%, according to CEO Robin Li.

The neck-and-neck competition has led Qihoo to offer developers a deal in which they get to keep 100% of proceeds from the first 500,000 renminbi that a game makes. After that, Qihoo starts to take a cut, co-CFO Zuoli Xu told analysts on a conference call last week.

"The more games (coming) into the market, the more prosperous the whole industry is," said Zuoli.

About 20% of Baidu's Q4 revenue came via mobile gaming and other mobile products, up from 10% six months earlier.

About 17% of Qihoo's Q4 sales came via mobile games. Mobile gaming sales jumped 131% to $63 million in Q4, outpacing overall growth at the company, co-CFO Zuoli Xu told analysts on a Friday morning conference call.

"We expect Qihoo's mobile game revenue to grow 260%" in 2014, wrote analyst He.

The number of companies building games in China grew 22.5% last year, according to mStoreTracker.

The boom in mobile gaming is attracting big players.

E-commerce giant Alibaba, which is widely expected to hold a U.S. IPO in 2014 and is partially owned by Yahoo (YHOO), announced in January that it would also launch a mobile gaming.

"Mobile games are too big a cake for Alibaba to pass up," iResearch analyst Cao Di told China Daily.

Alibaba says it's attracted to the industry because Chinese gamers are more apt to spend money while playing games than are Western gamers, wrote Melanie Lee, a writer with Alibaba-owned website Alizila.com.

Despite a heavy and continuing investment in mobile gaming, it's unclear when these companies will start seeing returns, according to UBS analyst Erica Poon Werkun.

Baidu's revenue growth has accelerated for the past three quarters. But its adjusted EPS rose just 6% in Q4 after Q3's 4% gain and Q2's 1% dip.

"We expect operating margin to remain under pressure in 2014," wrote Poon Werkun.

Mobile gaming sales accounted for 16.7% of all online gaming sales in China in 2013, according to iReasearch. That's expected to jump to 31.4% by 2017.

The app stores run by Qihoo, Baidu and others offer apps that run on smartphones using Google (GOOG) Android operating system. But Apple (AAPL), which only offers apps via its App Store, is benefitting too. About 44.4% of 2013 mobile game revenue in China came via handsets using Apple's iOS, according to iResearch.