THE CHINA TECH LETTER Qihoo 360 China’s Antivirus King Is Just Starting To Cash InResearch by …
Report Highlights 2Access To Nearly Every PC In China Chapters• 378mn Users: Every PC user in China needs what Qihoo has – security software. They want it for free, too, and Qihoo obliges. That’s made Qihoo second only to Tencent’s QQ messenger in terms of popularity with Chinese PC users, and given the scrappy underdog the nerve to directly challenge Tencent.• More Than Security: Qihoo’s extensive offering of software, portals and emerging cloud services is repositioning the company as a command center for the Web in China. It’s the starting point for users to 1. Quick View set up their PCs, a hub for cataloging and synchronizing content and apps among devices, and a launching pad for safely surfing the Web. 2. Drill DownMonetization Is Solidly Underway• Ads To Start: Qihoo collects ~75% of its revenue from ads placed on the default start-up page of its 3. Competition browser – a big change from three years ago when it made its money by selling security software. But by making its core software free, and bundling it with a browser, Qihoo now has access to a much larger user base that advertisers value. The 360 Browser is the second most popular in China behind Internet Explorer, 4. Management and the default start-up page, hao360.cn, had 45mn unique daily visitors in June, or about 10% of China’s Internet users.• Games: Though PC-based ads will serve it well in the near term, Qihoo is also promoting its open platform for web-based gaming as an alternative channel for monetizing its user base. Games generate revenue through in-game ads and the sale of virtual items, of which Qihoo takes a 65% cut.• Mobile Next: Qihoo already captures 58% of the active users of mobile security software in China. The firm is using its tried-and-true strategy of giving away the security software in order to get itself onto as many smartphones as possible, after which we believe it will begin monetization by placing text link ads on its bundled browser and by offering premium, fee-based security services.Plenty Of Room For Growth• Opportunity: Qihoo is already profitable and is still growing fast – revenue up 161% in 2011e. The firm currently trades at 37x our 2012 earnings forecast of $0.64 (non-GAAP), making it much more attractive than some of the other recent Chinese IPOs. The firm is creating a highly leveraged software and services platform based on trust and convenience – enviable assets when dealing with consumers -- and many view its product as a necessity, much like Tencent’s QQ or Baidu’s search tools. This gives it enormous potential to push new products to an increasingly savvy and demanding Net surfer in China.• Risk: Qihoo founder Zhou Hong-yi is a hard knocks entrepreneur unafraid to pick a fight. This has made Qihoo lots of enemies, the most powerful being Tencent. Already, the firm is working to erode Qihoo’s influence by investing in its closest rival, Kingsoft, and by blatantly copying one of its more innovative products, a GUI overlay for Windows that makes the desktop operate like an iPhone. If Tencent is able to successfully eat into these two markets, it will slow the growth of Qihoo and increase its costs if it has to August 31, 2011 fight for the attention of consumers through additional marketing campaigns.
4Qihoo Is A Strong, Scrappy ContenderThesis: We are positive about the Quick Viewlong-term revenue growthopportunity at Qihoo. As China’s Founded 2005leading software security firm, Qihoo Ticker QIHU. IPO 3/2011. Offered @ $14.50; opened @ $27.is used by nearly 380mn Internet 2011: ~$151mn, up 161% YoYusers. The 360 Safe Guard product Revenueisn’t the most robust, but it’s good 2012: $255mn, up 68% YoYenough and the price (free) is right. Target Audience PC and smartphone users.Consumers trust it, making themloyal and giving Qihoo a beachhead User base 378mn active users, ~92% of Chinese Net userson the PC matched only by Tencent’s Market ~85% PC; ~35% browser; ~60% smartphone Sharepopular QQ IM.We believe Qihoo is only at the early stages of monetizing its massive user base. By distributing related PC tools,like browsers and app aggregators, Qihoo will increase sales through ads and revenue sharing opportunities.Moreover, Qihoo is an early leader in the market for mobile security products just as China is starting to make itstransition to smartphones.The next step is leveraging its advantage in PC and mobile to create cloud services and synch products that elevatethe role of the 360 suite to an organizing point for all the digital content and clutter in a user’s life. We believe thiswill bind users even closer to Qihoo, thus increasing its influence among advertisers while also making it a moreattractive partner for third party application developers.Risk To Our Thesis: Qihoo doesn’t just have competitors, it has hard-earned enemies. From Alibaba and Tencent,to Kingsoft and Netqin. Qihoo management, led by the controversial Zhou Hongyi, isn’t afraid to instigate a fightand then win it by questionable means. Even though it’s shown an ability to bloody the nose of industryheavyweights like Tencent and come out relatively unscathed, the company’s combative style will always be a riskfor negative news flow that could spook investors.Other risks include a slowdown in advertising revenue, especially from the e-commerce sector, which represents40% of ad sales and 30.5% of total revenue. Qihoo will also continue to face considerable competition in antivirus,browsers, gaming and app distribution.
5 Qihoo’s User Base Rivals Other Net Giants 710mn Measured by users. 378mn 370mn 278mn Tencent* Qihoo* Taobao** Sina** * By Active User Accounts. ** By Registered User AccountsSource: iResearch 2011.02
6 Ads Major Driver Of Strong Revenue Growth Google’s percentage of Qihoo’s revenues has decreased from 21% in 2010 to 11% in Q2 2011, although the absolute amount of revenue from Google has been increasing.Source: Company, RedTech Advisors estimates
7Qihoo SWOT Analysis Strengths Weaknesses Huge, loyal user base of security software. Search engine referral commissions come Reputation for safety & reliability plays well mainly from Google. Baidu and Qihoo are into new markets. locked in a court battle over past fees. Qihoo’s web browser is the only successful e-Commerce accounts for 40% of ads competitor to Internet Explorer in China. revenue. Any drop in client spending there would have a significant impact. Ad client base at 210 and growing. Top 5 customers account for 35% of revenue in Qihoo & CEO Zhou Hongyi have made 2010. many enemies, which may limit partnerships. Profitable. $308mn on balance sheet, User base still unproven as a cash cow. which positions it for acquisitions. Consumers use Qihoo products in part to avoid ads. Opportunities Threats Ad revenue just starting to take off. User Baidu and Tencent want to be bigger base relatively untapped for direct players in the PC safety market, the monetization via games, e-commerce, etc. cornerstone of Qihoo’s success. Tencent already copying Qihoo’s desktop app. Gaming starting to gain momentum. In mobile, rival Netqin (invested by Mobile product can offer fee-based Qualcomm and Mediatek) will try to displace premium services (but not till 2013/14). Qihoo, threatening a huge future revenue Strong potential to further bind users by source. integrating and simplifying the management The company is built upon its reputation of software and content across the PC, for safety and integrity – not flashy products mobile and app store. or services. One crisis could be disastrous.
8Recent Performance• Strong in August: Qihoo outperformed the major US indexes in August, ending the month with a 3.25% gain MRQ Quick Read 2Q10 2Q11 YoY Change against declines of 6.41% in the NASDAQ, 5.67% for the Total net revenues (US$mn) 12.7 35.1 177% S&P 500 and 4.36% for the Dow Jones. Online advertising 8.5 26.8 216%• Valuation: At $23.80, Qihoo trades at ~70x our 2011 Internet value-added services 3.1 8.1 159% earnings estimate of $0.34 and 37x our 2012 estimate of Gross profit 11.2 31.4 180% $0.64 (non-GAAP). This is no value stock for sure, but Gross profit margin 88.3% 89.5% 1.2ppt we are bullish on its growth prospects and would be buyers on any weakness, especially below $20. Income (loss) from operations 2.4 12.7 434% Operating margin 19% 36% 17.5ppt• Volatility: During last two months, mostly trading in the $20-$25 range, with a short-lived dip below $20 in Net Income (loss) 2.2 11.1 410% August before its earnings announcement, which handily Net margin 17% 32% 14.5ppt beat its earlier (conservative) estimates. We expect to Non-GAAP Net Income 1.0 13.2 1199% see more interest in the company as sell-side coverage Net Income per ADS (diluted) 0.05 0.09 80% increases and management hits the road in the Fall to better communicate its position and strategy in China. Non-GAAP Net Income per ADS (diluted) 0.02 0.11 358% 8 Source: Google
91-Month Performance: Qihoo up 3.8% in August.5-week Performance: Qihoo outperforms security peers. Trend Micro: -5.4% NASDAQ: -9% Symantec: -9.9% Qihoo: -3.8% Kingsoft: -23.1%Source: Google
105-Week Performance: Qihoo outperforms most of China Internet Peers. NASDAQ: -6.7% Tencent: -11.9% Baidu: -1.6% Qihoo: -3.1% Kingsoft: -21.9% RennRenn: -33% Youku: -24.1%3-Month Performance: Qihoo performs well against China Internet Peers. Kingsoft: -2.9% Baidu: +7.4% NASDAQ: -9% Tencent: -17.4% Qihoo: -8.8% RennRenn: -42.9% Youku: -40.7%Source: Google
12COMPARABLES EPADS - EPS P/E P/S PEGName Ticker Share price Market cap Currency Gross margin 2011E 2012E 2011E 2012E 2012E 2012EQihoo 3 60 QIHU 23.8 2.94B USD 89.5% 0.34 0.64 70.0 37.3 12 0.1Baidu BIDU 145.78 50.87B USD 74.2% 2.9 4.37 50.3 33.4 15 0.4Symantec SYMC 17.15 12.86B USD 84.3% 1.64 1.82 10.5 9.4 1.8 0.9Kingsoft 388 8 HK 0.53 0.6B USD 86.8% 0.04 0.05 13.2 11.1 3.5 0.6Tencent 070 0 HK 24.11 44.2B USD 65.4% 0.75 0.96 32.3 25.1 9.5 0.7Profit & Loss Balance SheetFY ends Dec 31 (Figures in US$) 2009A 2010A 2011E 2012E 2013E Current assets 2010A 2011E 2012E 2013ERevenue 32.3 57.7 150.7 254.9 393.0 Cash and cash equivalents 60.5 270.1 317.8 394.7 Online advertising 13.9 38.8 113.2 189.8 294.6 Accounts receivable 8.2 21.3 36.1 55.6 Internet value-added services 2.1 14.8 36.6 64.1 97.4 Other current assets 3.9 3.9 3.9 3.9 Others 16.3 4.1 1.0 1.0 1.0 Cost of revenues 8.4 6.8 17.1 34.9 59.6 Non-current assets Gross profit 23.9 50.9 133.6 220.0 333.4 Property and equipment. Net 3.3 4.5 5.7 5.9 Operating expenditure Long term investment 2.0 2.0 2.0 2.0 Research and development (10.7) (24.5) (56.4) (86.8) (133.9) Other non-current assets 9.9 9.9 9.9 9.9 Sales and marketing (6.3) (12.6) (39.4) (36.8) (51.1) Total assets 87.8 311.8 375.4 472.1 General and administrative (2.5) (5.1) (16.1) (25.7) (39.6)Operating profit 4.5 9.0 21.9 70.7 109.0 Current liabilities Income tax expenses (0.4) (0.5) (8.9) (10.8) (16.5) Accounts payable 1.4 3.6 6.1 9.5Net profit attr. to shareholders 2.1 5.5 15.3 61.1 93.3 Others 12.5 12.5 12.5 12.5 Non-current liabilities 1.0 1.0 1.0 1.0Cash FlowOperating cashflow 9.0 20.1 10.5 60.2 96.2 Convertible preferred shares 70.2 - - - Net income 4.2 8.5 15.3 61.1 93.3 Depreciation & amortization 4.1 1.3 6.2 11.3 19.1 Additional paid in capital 12.6 289.2 289.2 289.2 Change in working capital (1.5) 6.3 (10.9) (12.2) (16.2) Retained earnings (13.6) 1.6 62.8 156.1 Others 2.2 4.0 - - - Noncontrolling interest 0.5 0.5 0.5 0.5 Total equity,preferred shares 2.7 294.7 355.8 449.1Investing cashflow (4.2) (9.1) (7.4) (12.5) (19.3) Purchases of property and equip. (0.8) (2.8) (7.4) (12.5) (19.3) Others (3.4) (6.2) - - - Key assumptions 2010A 2011E 2012E 2013EFinancing cashflow - 20.3 206.5 - - Growth Proceeds from IPO - - 206.5 - - Revenue 79% 161% 69% 54% Others - 20.3 - - - Online advertising 179% 192% 68% 55% Internet value-added services 621% 148% 75% 52%Cash at the beginning of year 23.3 28.1 60.5 270.1 317.8 Gross margin 88% 89% 86% 85%Cash at the end of year 28.1 60.5 270.1 317.8 394.7 OPEX as % of revenue 73% 74% 59% 57%
13Drill Down Financials, Product, Competition, StrategyBack to Top
14Qihoo 360 Product: Browser with 65 games and 20mn users in Aug. 2011. Sales Key Revenue GeneratorsProduct Suite generated via monthly subscription, hourly rates &/or paid items. Strategy: Gaming accounted for 18.8% of Qihoos Q2 revenue. Currently, most popular games are 2D RPGs and strategy games, but Qihoo is pushing into casual games. Product: Simplifies Product: Interface that runs installing/removing programs on top of the windows on PC. Released Dec. 2006. desktop. Dresses up Windows to look and work like an iPad Strategy: No direct revenue, but serves and offers access to 100k as convenient conduit for new software.apps from iPhone and Android app catalogs. Constantly updates Qihoos software to10mn active users as of Aug. 2011. improve stickiness, while offering wideStrategy: Moves Qihoo 360 brand closer to variety of software from third partiesentertainment and leverages access to (though it favors Qihoo software). Hasconsumers via direct links to Qihoos other been mimicked by Tencent and Baidu.revenue generating channels. Possiblefuture opportunities for syncing withQihoos mobile software Safe-Guard, which Core product: Qihoos strategy oftargets China’s growing smartphone base. giving away Safe Guard won it a foothold on the PCs of more than 90% of Chinas Internet users. Since its release in 2006, Qihoo has followed up with numerous other products aimed at monetizing its massive user base. Product: Smartphone version of Qihoos safety suite. Released in Nov. 2009. #1 market share with Product: Basic browser and home page. Only 58% of active users of mobile browser to take significant market share from security software in Jan. 2011. Internet Explorer, with 200mn users and a 35% market share based on actual usage. Strategy: Mobile software also free, as part of Strategy: Start-up page accounted for 77% of a land grab for Chinas growing smartphone revenue in Q2. Browser preset to use 360s start- market. Not expected to monetize until 2013. up page, which had 45mn unique visitors per day Syncs with Qihoo desktop software, allowing in June. Ad demand outpacing supply. Ad prices users to control phone software. determined by bidding system; prices increasing.
15 Key Products Among Most Popular In China Trusted Partner: With 92% coverage of China’s Internet market (i.e. a user base of Room for 378mn active users), Qihoo 360 user has saturated the Chinese PC growth within safety market and is a considered Qihoo’s a household name in China. existing However, the ‘Qihoo 360’ name is base. synonymous with ‘free antivirus’ and thus Qihoo’s challenge is enticing its user base to try its other products & services. Next Step: The company has Growth in Qihoo Key Products shown promising results gaining traction with its browser, which is the key source of its revenue via ads on the browser’s default start-up page. Qihoo needs to replicate this success with its gaming services and open platform desktop, which are in the early phases of introduction. 15Source: RedTech Advisors, iResearch, * Avg. daily unique visitorsin June 2011
16Strategy Shifting Toward Diverse MonetizationAgency Model: Qihoo’s 360 Safe Guard and Software Qihoo’s Revenue SourcesManager paved the way for Qihoo’s subsequentreleases. Until mid 2008, Qihoo made most of itsmoney by acting as an agent for antivirus companieslike Kaspersky.Shift to Ads: In 2008, Qihoo launched its ownantivirus for free along with its 360 Safety Browser.This marked a key shift toward monetizing its basethrough advertising, mostly via paid links on thebrowser’s landing page.Platform Strategy: The company has nearly phased out revenue from third-party antivirus sales and nowreceives ~95% of revenues from ads and gaming. It continues to build out the product suite to improvemonetization. Mobile security will be the next big opportunity, with a business model based on free and fee-basedpremium services.Key shift to ads model Next big opportunity
17Launch Pad – Qihoo’s Channels to Revenues Overview of Qihoo’s Revenue Generating Potential
18 Qihoo Margins Will Remain Robust • We expect gross margins to hover around 85-89% for the immediate future, and edge down slightly to 85% beyond 2013 as a result of lower margin revenues diluting higher margin ad revenues. • SG&A as a % of revenue should decline YoY as revenue grows. The company had higher than normal marketing costs in 2010 due to a marketing campaign highlighted by a commercial on CCTV. (See below). Money well spent as it saw a spike in users during the same period. We have modeled conservative opex as we expect some heavier spending in 2012 to fend off Tencent. • R&D expenses should drop slightly but continue to stay in the 35-40% range. Of the 860 employees at Qihoo, 722 were in R&D and only 88 in sales and marketing. Qihoo 360’s 2010 commercial on CCTV “360 Anti-Virus will always be Free!” (1Q11A spike in Sales & Marketing due share based compensation.)Source: Company, RedTech Advisors estimates
19 The Core: Qihoo 360 Safe Guard Q: How good is Qihoo • Qihoo 360’s security software isn’t just anti-virus. It’s more of a computer efficiency command center – akin to Tune-Up Utilities combined with anti-virus. For instance, Safe antivirus? Guard runs maintenance tasks more typically found in Microsoft’s control panel, such as defragmenting, while also taking care of more mainstream security tasks, such as scanning A: Good enough. for malware. Its freebie status may get people interested, but it’s the ease of use and AV-Comparatives awarded effectiveness that keeps users loyal. Qihoo’s antivirus the same rating as Bit-Defender and • After Safeguard , Qihoo released an extension called the 360 Software Manager – basically McAfee. Some tests give a glorified browser with extensive listings of Qihoo and third-party software (akin to CNET’s Kingsoft and Kasperky products Download.com). The convenience comes from being able to download, install, update slightly higher ratings, but the and/or uninstall all programs from within the manager. Of course, Qihoo ranks its software difference is not enough to higher than others, a major catalyst for getting more Qihoo software onto user computers. disrupt Qihoo’s leading position.System Scan Kill Trojans PC Clean-up Software manager Most of the IT professionals we Bug Fix System Repair talked to use 360 on their personal PCs. Qihoo Awards List China Internet Weekly Editor’s Choice Award Approved by China Ministry of The 360 Safe Guard interface. With a Public Security score of 97, this PC looks relatively clean. The program suggests three Virus Bullentin’s optimizations: Scan for worms (trojans), VB 100 award check for software updates, clean out documents in the garbage. AV-Comparatives Advanced Level OPSWAT Bronze Certification West Coast Labs ‘Checkmark’
20 Browser Key Sales Conduit Safe Browser Chrome Browser iPad HD Browser Android Mobile Lynchpin: Qihoo’s browser is integral to driving traffic to its Browser (Pending) portal, where clients pay to place text links to their sites. The Strengths browser also includes a search bar from which Qihoo earns referral fees, mainly from Google. Qihoo had partnered with • Only browser to grab significant market share from Baidu, but they had a falling out and Qihoo is suing for IE. Currently holds ~ 35% of the China market. $7.6mn in contested referral fees. • Safe Guard prompts user to install browser. • Uses Trident (IE) and Webkit (Chrome) engines. Secure Position: China’s web browser market is still dominated by Microsoft, but new players like Qihoo are slowly Many Chinese sites only load properly on Trident. eroding its position – down 10ppts in the last year to 50%. • Syncs browser preferences with Qihoo account. Qihoo is second to Internet Explorer, with about 35% share, • Auto updates to solve bugs and gradually introduce and based on user reviews and our tests of the competition new functions (i.e. Baidu’s Beta Browser), Qihoo has a superior product that • Early mover advantage. Released in 2008. should help it continue to gain market share. Weaknesses Browser Market Share Determined by Usage • 360’s Safe Browsers reputation is based on safety. A publicized flaw in browser security breach could negate years of growth. Opportunities • New Chrome & iPad versions add incremental gains. • Navigation bar contains links to Qihoo’s Gaming Center Threats • Constantly fending off competition. Sohu bundles browser with China’s most popular pinyin input tool. Baidu also entering the market.Source: CNNIC & Redtech Estimates
21 Cash Cow: 360 Start-up Page Simple but effective: Preset as the browser’s start-up page. There are links to Qihoo’s competitors and no blatant advertising aside from a few colored links. The landing page links to Qihoo’s key sub-pages: an e-Commerce aggregator site, a group buy aggregator site, and their online gaming site. Monetization: Start-up page adds comprised 64% of Qihoo’s Q211 sales, up from 46% in Q210.* Growth driven from increasing bid prices due to increasing page views. Qihoo heavily relies on e-commerce ads to drive revenue, so any softening there would be a substantial risk. That is unlikely to happen in the next few years as the popularity of online shopping increases and sites vie for traffic. Search referral revenue will increase on an absolute basis, but decline as a percentage of revenue. Google is default for Qihoo’s portal search referrals in had 98mn users browser, though it can in January. be easily changed. Unique daily visitors hit Above, Qihoo Group Buy aggregator. 45mn in June, (Click here to view) up from 38mn in Paid links: Unlike - Searchable by specific criteria. March. Average traditional banners, - Advertisers pay for positioning. clicks per visitor these are simple hit 3.06 in June text links that track Below, Qihoo’s e-Commerce aggregator. up from 2.81 in back to popular (Click here to view) March. websites, including Baidu, Sina, Netease, Youku, and RenRen. Sales generated via Links to group buy, bidding for ad e-commerce and position, not based gaming sites. on pay for performance.*Qihoo’s Online Advertising in the SEC filings includes Search Referral commissions, which we excluded.
22 How The Keyword Ad Model Works Qihoo does not charge ‘per click’ with advertisers, but charges monthly fees for links, priced on the most up-to- date traffic data. To ensure the end-user functionality of the landing page, Qihoo maintains the same ratio of ad- space across verticals, and then operates a closed bidding system within each vertical. For instance, the ad space in Local Food Deals of the Group Buy section is regionalized with an ad in the top four rows costing 50,000 yuan/month in Beijing, and 20,000 yuan/month in Tianjin.Signifies a click Start-up Page leaving the Start-up page 10% of 33% of 17% of 40% of Ad Revenue* Ad Revenue Ad Revenue Ad Revenue** Front Search Group Buy E-Commerce Gaming Personal Page Center Interests Links Link to Link to Retailer Retailer Search Category Link to Site Results Sub-Pages: i.e 360 In-Browser Links to Search Sub- Search Sub Search Sites Aggregator Page Aggregator rebates, luxury items, Games Aggregator Pages sales events, top Taobao stores. End End In-Game Other Link External Retailer Retailer Browser Pages to Site Search Listings Search Aggregator Page Aggregator **(Including searches through Qihoo’s browser) Link to End Link to End Retailer Retailer *(Group Buy accounts for roughly 5% of the 40% )
23 Start-up Page Popular Cash Model In China The landing page is a pretty standard and successful model in China. The two most cited reasons for users leaving landing pages are 1) Lack of Impartiality 2) Homogenization of content. Qihoo’s lack of presence in the search industry gives users the impression of impartiality relative to sites owned by search engines. hao123.com 265.com 2345.com hao.360.cnPurchased by Baidu in 2004 Purchased by Google in 2007 Independent Landing Page Qihoo 360’s Landing Page Founded in 2005 Chinese Netizens Reviews:Positive: Clean & neat, fast, Positive: Includes standard Positive: Straight forward Positive: Standard layout,one of the earliest landing basic features of email, search, layout, presenting weather… good category specific searchespages weather Negative: Relatively small Negative: Using a .cn domain Negative: Font is smaller than number of URLs. has drawbacks.Negative: Relatively FewFeatures. competitors, page is a little Commentary: The domain cramped name is easy to remember and Commentary: Many users viewCommentary: Baidu’s support 360’s landing page as an by far the easiest to type.and it’s inherited users give Commentary: Strong backing independent alternative tohao123.com top spot. of Google and good flow. Google & Baidu’s offerings
24Gaming PortalsSecondary DriverWeb Page: Offering ranges from mini-gamesto MMORPG, FPS to real time strategy, andeven some links to Cosplay and Anime sites.Naturally, Qihoo promotes revenue-generatinggames but it also realizes the market is full ofnon-revenue generating games, which aremostly pirated foreign games.Qihoo lists all these games, but does not hostor pirate them – sending users instead towebsites like ali213.net or gamersky.com,where gamers can find a torrent file todownload. Qihoo does a good job of keepingits hands clean by not directly breaking any IPlaws, while still staying relevant to gamers byacknowledging the massive pirated gamesmarket in China. Qihoo does not create in-house games. Gaming Browser: Nothing revolutionary. Basically, just a link on the desk top that opens up a browser to select games. It eats up less memory than an internet browser and has a few other features, such as a “boss button,” but on the whole it’s ordinary and simply another way to access games.
25Gaming Risk/Reward Gaming Dominates IVASPositive: Healthy increase in registeredusers in games center over last sixmonths, from 14.7mn to 20mn. Qihoomakes money by splitting revenue withgame companies at a rate of roughly 52% (YoY)65:35 (Qihoo:Developer). Fees aregenerated from subscriptions and/or thepurchase of virtual items. 75% (YoY)Negative: Qihoo isn’t a gaming companywith a strong understanding of that 147% (YoY)market, so difficult to predict how quicklythis segment will accelerate, especially 621%(YoY)given that competition is increasing forweb-based and casual games fromspecialists like Shanda and Tencent.Gaming: Set to take off or destined for mediocrity? Qihoo Gaming Stats Q211Partnering with game developers to share revenues is the closest that Qihoo Cut of Gaming RevenueQihoo has come to actual content creation. But based on Qihoo’s (after 65:35 split) $6.6mnreported 20mn registered gamers, Qihoo’s revenue per gamer is low. Total Gaming Revenue $10mn 20mn Registered Users $0.5 per gamerThe success (or lack of) of Qihoo’s gaming endeavors could act as a Rmb per gamer 3.42 yuancanary in the coal mine for Qihoo’s future ventures. However, that Average monthly spending 1.14 yuanmay be a shortsighted judgment. It seems that Qihoo’s managementhad a false start with their initial strategy of pursuing a Blizzard Entertainment model for online gaming, and are nowrecalibrating their sites on a Zynga approach via casual games. Regardless of your take on gaming as an indicator toQihoo’s future, gaming is currently Qihoo’s only viable revenue supplement to advertising and thus deservesattention.
26Qihoo 360 DesktopInnovative: Turns desktop into a formatsimilar to an iPhone interface. Activating the360 desktop in full screen mode replaces allthe Windows shortcuts with apps and createsseveral screens, akin to the iPhone interface.Users slide screens to search for shortcuts. Strengths• Has 10M users as of Aug. 2011.• Direct Access to 100,000+ free apps, many coming from iPhone & Android catalogs. Sets the stage for Qihoo to become an apps store.• First firm to creatively use the ‘desktop’ Windows Desktop approach. Sub-browser of ‘Tools’ to access Weaknesses commonly used programs Toggle between Windows• Monetizing may prove challenging as Chinese & 360 desktops users accustomed to free app stores.• Reviews have been positive, but users complain platform lacks customizing options. Default sample widget Opportunities• Plans to start monetizing in 2012.• Synch to 360 Mobile for cross platform app store.• Positions Qihoo closer to the entertainment Slide laterally to multiple desktops, similar to iPad/iPhone delivery side of the internet. Windows task bar remains Threats• Competition potentially coming from Tencent 360 Desktop copycat product that recently hit the market.
27 360 Mobile Safe: ‘The Next Frontier’ Opportunity: Of the roughly 860mn cell phones in China, about a sixth, Available On: 143mn, are smartphones. This number is only going to grow, particularly as handset makers start to focus on the lower end of the market. Strategy: Qihoo is replicating its free antivirus model to grab users in the growing smartphone market. According to a report from Qihoo in July 2011, about 8% of smart Supporting Software phones were found to be infected with some type of virus of malware. While these viruses may not be fatal to a cell phone, the lingering threat of some malware eating up 360 Ipad Hi-Def a users monthly data plan should be enough encouragement for a user to download Browser: Launched in Qihoo’s software. Aug. 2011 Function: Monitors monthly data usage, blocks SMS spam, and deletes virus & Qihoo 360 Kouxin: malware. Qihoo’s software also synchronizes with Qihoo’s desktop software manager so Cross platform instant users can control application download and removal when synching their phones with messaging application. their PC. (Similar to “What’s App”) Monetization: We don’t see Qihoo monetizing Mobile Safe until late 2013. This may be 360 Android Browser: expedited depending on the popularity of 360 desktop and app store, or pressure from Coming soon competitor Netqin, which also gives its software away but charges for updates and premium services. 2009-2014 GAGR = 75% Qihoo claims 52% of active users. Available on …Source: Frost & Sullivan Source: iResearch, Jan 2011
28Products Geared Toward Leverage Software & App Internet Managers Browsing 360 Safe 360 Software Guard Manager 360 Web 360 Anti- Shield Virus Device Safety 360 360 File 360 Mobile 360 E-Commerce Compression Safe Box Safe Guard Bodyguard 360 iPad HD Browser Gaming 360 360 Start- 360 Desktop up Gaming Page Browser 360 Safe Browser 360 Open ID: 360’s webpage & browser sign-in is used to register on 3rd party websites, such as Group buy sites that advertise on Qihoo’s website.
29Competition Tencent, Kingsoft, NetqinBack to Top
30Tencent-Kingsoft Combo Biggest Threat• Tencent & Kingsoft: Kingsoft’s anitvirus software was released in 2002 and is still well regarded. However, consumers were not willing to pay for something Qihoo gives them for free. So in Nov. 2010, Kingsoft capitulated and started giving its antivirus away, too. Yet, by then the once dominant Kingsoft had shrunk to a 14.6% market share. In July 2011, Tencent bought a 15% stake in Kingsoft, hoping to strengthen its offering to the more than 300mn-plus PC users that already have Tencent’s software installed on their PCs. A key figure to watch in the coming year, is the adoption rate of the package set of QQ software manager and Kingsoft’s Anti-virus. This combo is the most likely competitor to erode Qihoo’s core user base, and could represent a significant threat to Qihoo’s future growth.• Rising: Rising still holds 11% of the domestic market, and as of March 2011, it’s free. It’s internet security program and anti-spyware received the same Bronze rating as Qihoo from Opswat. Rising has also released a browser, though it hasn’t gained significant market share. 30
31Tencent Already Replicating Desktop App• Tencent’s Q+: At the end of 2010, Tencent announced development plans for ‘an open QQ interface’. It launched in May, 2011, two months after 360’s desktop, and is pretty much a copycat in typical Tencent fashion.• The key difference between Qihoo’s 360 Desktop and Tencent’s Q+ is the social aspect tied into Q+. It allows users to seamlessly tie in social aspects into their games, while Qihoo’s apps do not. In other words, Q+ can use Tencent’s social leverage (i.e. Qzone, Pengyou, Weibo and QQ IM) to link members together for group games or other entertainment, similar to Facebook. Qihoo will need to form partnerships with other SNS sites to substantially improve its SNS feature. Q+ 360 Desktop Use of RAM ~17MB ~17MB User Interface Mediocre (lacks pre-loaded features) Above Average. Smoother interface than Q+. Much better job of recommending apps Number of Apps Few (so far majority are Q+. Q+ has yet to cultivate Tons, ~100,000, majority recycled from app- the ‘open’ environment it promised developers) platform catalogues Quality of Apps Satisfactory Mediocre (Majority are mini-games) SNS capability High, sync with QQ account Low Room for expansion Merge with QQ’s services Yet to be seen how Qihoo will integrate with other 360 productsSimilar side bar Tencent’s Q+ Desktop Widgits Qihoo’s 360 Desktop Toggle between Windows Desktop Widgits Similar side bar Toggle between Windows Desktop 31
32Management Key Execs & VIE StructureBack to Top
33 In Your Face Management ‘My Job In China Is To Kick Google’s Ass*’: Qihoo founder Zhou Hongyi is one of the most colorful characters among China’s Internet aristocracy. He’s traded blows with Google (and lost) and Alibaba’s Jack Ma (and won) and Tencent’s Pony Ma (a draw). He first gained attention as the founder of 3721.com, a search firm bought by Yahoo for $120mn (cash) in late 2003. He and his inner circle then ran Yahoo China until being forced out by Jack Ma in 2005 when Alibaba took control of Yahoo China. Miraculously, Qihoo was up and running nearly overnight – accusations still linger that Zhou personally paid engineering teams he oversaw at Yahoo to moonlight on Qihoo. In a jab at Yahoo and Ma, Qihoo’s security software labeled the 3721/Yahoo software as malware and encouraged users to delete it. The ensuing public finger pointing between Yahoo and Qihoo created a media blitz of coverage. Qihoo came out The rhyming of Qihoo & of it relatively unscathed in the public’s eye, but Yahoo, and more importantly, Jack Yahoo is no coincidence. Ma has not forgotten. This type of combativeness is a trademark of Zhou.Qihoo Chairman & CEO Zhou Hongyi Media Coverage of Qihoo-Yahoo conflict • Born: 1970, Hubei Province Naturally the Chinese tech- • Education: Masters in Computer media loved the story line Engineering from Xian Jiaotong University. and had a field day with it. In • Founder of 3721.com the cartoon above Zhou • President of Yahoo China Mar.’04-Aug. ‘06 Hongyi gestures at Jack Ma. The adjacent magazine title • Partner at IDG Venture Capital reads “Zhuo Hongyi: I am not • Deep ties with in China’s VC network a hypocrite”. Qihoo’s Inner Circle From 3721 & Yahoo China Qi Xiangdong Shi Xiaohong Shu Cao President of Qihoo 360 VP of Technology Chief Engineer Formerly: Formerly: Formerly: • VP of Yahoo China • CTO of Yahoo China, • Chief Engineer of Yahoo China • GM of 3721.com • CTO & Co-founder of 3721.com • Co-founder of 3721.com • Vice Bureau Chief for Technology, Xinhua (government news agency) *Source: Danwei.org
34Qihoo Is No Stranger To Conflict At War with Tencent Oct, 2010: Affectionately refferred to as the “The 3Q War”, Qihoo 360 and Tencent had a public battle that stemmedfrom allegations of privacy issues, and turned into a deadlock forcing users tochoose one of the companies.In brief, a Qihoo suggested that Tencent’s QQ program may be scanning personaluser files, and Tencent countered that Qihoos browser was misdirecting its clientsto questionable sites.In the coming month the mud-slinging escalated to lawsuits, and then users wereforced to choose between Qihoo’s safety software or Tencent’s instant messengerQQ. At this point, the Ministry of Information and Technology ordered both sidesto resolve the software conflicts and cease all negative statements. Weibo Clash May, 2010: Kingsoft’s CEO ‘tweeted’ on his Weibo account that Qihoo was behaving in an unscrupulous manner. Qihoo’s CEO Zhou Hongyi retorted via his weibo account “so sue me.” Kingsoft did. Zhou Hongyi lost a reputation infringement case and had to pay roughly US$12,000 in damages to Kingsoft and had to post apologies on his Weibo account for a week. Kingsoft’s unfair competitive practice suit is still pending, as is Qihoo’s counter suit. These lawsuits are mostly for theater. Lawsuits of this nature rarely have a strong ruling in China and will unlikely have any material affect on Qihoo’s operation. Suing Baidu May, 2010: Qihoo filed a breach of contract claim against Baidu for Suing Rising unpaid search results, asking for US$7.6mn in damages, losses and Feb, 2010: Qihoo is interest. Baidu filed a counter claim for US$1.6mn. $7.6mn would’ve suing Rising for been equal to 24% of Qihoo’s 2009 revenue, significantly more than misleading users into Google during that period. thinking that 360 Safe Guard poses security Qihoo currently does not have an agreement in place with Baidu for risks. This case is search referrals, but Qihoo still keeps Baidu listed on search bar on the pending and we do not start-up page for user’s convenience. If Qihoo can come to an amicable believe that Qihoo will agreement with Baidu, it could quickly give Qihoo’s top line a boost in obtain any significant the realm of 10% (conservatively based Google’s contribution to settlement. Qihoo’s revenue). Unlike Qihoo’s other quarrels, this one has stayed out of the media limelight, and is worth following closely.
35 Corp Structure & Management OwnershipManagement Stake: 39.5%Zhou Hongyi, CEO: 18.6%Qi Xiangdong, President: 10.8%Cao Shu, Chief Engineer: 7.1% Qihoo 360 Technology Co., Ltd.Shi Xiaohong, VP Technology: 3.8% (Cayman Islands) 100% 100% 100% 360 International Qifei International Qiji International Development Co. Limited Development Co. Limited Development Limited (Hong Kong) (Hong Kong) (Hong Kong) Outside PRC 100% Inside PRC Qizhi Software (Beijing) Co., Ltd. Beijing Qihu Technology Beijing Qihu Network Technology Five Other VIE’s Company Limited (PRC) Computer Limited (PRC) (PRC) Contractual arrangements consisting of equity disposition agreements, loan agreements, equity pledge agreements, business operation agreements, technology development agreements and power of attorney.
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