Initiation China: Internet Software & Services 13 December, 2013 Action What’s new? Our view BUY (Initiation) ► We initiate coverage of Qihoo ► Qihoo has established a leading TP upside (downside) 43.9% position in China’s antivirus 43.9% upside. and app distribution segments price of US$115, which implies Close 11 December, 2013 Price 12M Target Previous Target NASDAQ with a BUY rating and a target US$79.91 US$115.00 N.A. 4,003.8 software, website navigation, via several popular mobile apps. ► We believe PC/mobile internet monetization is on track. Company profile: Primarily known for its antivirus software, Qihoo is the largest website navigation/mobile assistant supplier and second largest search engine player in China. Share price performance relative to NASDAQ 101 Share Price (US$) Performance relative to NASDAQ (%) 200 91 81 150 71 61 100 51 41 50 31 21 Nov-12 0 Feb-13 May-13 Market cap 6M avg. daily turnover Outstanding shares Free float Aug-13 US$10,176.6 mn US$202.3 mn 122.8 mn 52.4% Hongyi Zhou, 17.7% Net cash US$6.10 13.1x Major shareholders Net debt/equity BVPS (2013F) P/B (2013F) Financial outlook (US$ mn) Year to Dec 2013F 2014F 2015F Sales 329 664 1,054 1,423 Op. profit 233 487 802 1,033 Net profit 47 174 262 401 EPS (US$) 0.40 1.45 2.20 3.36 EPS growth (%) 197.9 267.2 50.9 53.1 DPS (US$) 0.00 0.00 0.00 0.00 P/E (X) 201.7 54.9 36.4 23.8 Div. yield (%) 0.0 0.0 0.0 0.0 ROE (%) 11.0 28.8 30.3 33.0 Initiate with BUY: Qihoo has leveraged its leading position in antivirus software to promote its search engine and 360 Mobile Assistant, as it looks to establish its products as a gateway for the internet. The company is among the top three PC/mobile internet traffic distributors in China, but is still in the early stages of monetizing this traffic. We expect mobile games to be a significant revenue driver for the company going forward, with the market expanding at a 37.0% CAGR from 2012-15F. ► Well positioned in both PC and mobile: Its dominant share of PC/mobile antivirus products in China and promotions via these products are helping the company establish a leading position in app distribution. Qihoo has subsequently become a challenger to ► Still at the early stage of monetization: Qihoo had a 21.7% share of search traffic in China in October, but just a 1.6% share of search revenue in 3Q13. However, mobile games have seen fast growth in 2013 and will continue to gain momentum in the years ahead. We expect net profit to expand at a 48.8% CAGR from 2013-16F. ► More innovative products: Its focus on user experience and innovation has helped Qihoo define user needs and quickly launch related products. We expect the company to launch a mobile search app and more wearable devices in 2014F. ► Valuation: The stock is currently trading 36.4x 2014F EPS. Our TP of US$115 is derived from the average of DCF and PEG valuations. Primary Analyst: Nice Wang Nice.Wang521@yuanta.com With significant contribution from: Nice Wang +86 21 6187 3824 Search and mobile games driving rapid growth more established names in the PC search market. 2012 +86 21 6187 3821 Qihoo (QIHU US) andy.wang201@yuanta.com ► Risks: If Qihoo fails to form an alliance with another internet giant, its monetization may be slower than we expect. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ARE LOCATED IN APPENDIX A. Yuanta does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Investment thesis Its business model is to acquire a vast user base via free popular products and make money from other avenues Quickly reaching internet users Qihoo has established a number of gateways to the internet, such as its PC/mobile antivirus products, its search engine, mobile app distribution platform, and internet browsers. Its business model is to acquire a vast user base via free popular products and make money from other avenues. Qihoo is the dominant internet antivirus product supplier in China with 465 mn PC users and 408 mobile users in 3Q13. It has no powerful competitors in China thanks to its strategy of giving its products away for free, and new competitors will not threaten its dominant market position, in our view. Antivirus products are Qihoo’s key channel to promote its other products, such as 360 Mobile Assistant has more than 300 mn users, and is the largest third-party Android app distribution platform in China 360 Browser, 360 Search, 360 Website Navigation, and 360 Mobile Assistant. Unlike other software or apps, antivirus products are always running and always monitor users’ operations, and we view this platform as ideal to promote products to PC/mobile internet users. Furthermore, Qihoo’s 360 Browsers had a 26.09% market share in November in China, second only to Internet Explorer, while 360 Mobile Assistant has more than 300 mn users, and is the largest third-party Android app distribution platform in China. The company is also focused on start-ups because of CEO Hongyi Zhou’s angel investor background, and has invested in some successful companies such as PP Assistant, which was just acquired by UCweb. Qihoo has good relationships with lots of venture capital firms, which can help it keep in touch with new internet development trends. Figure 1: Qihoo has already well positioned in both PC and mobile internet market Source: Yuanta Research Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 2 of 27 Figure 2: Qihoo’s PC user base PC safe products users 500 Figure 3: Top 10 antivirus products in China 1H12 product penetration 100% mn Ranking Software Monthly Unique User Chg % 1 360 Security Guard 369.4 10.7% 2 360 Antivirus 360.8 20.9% 3 QQ Computer Guard 84.1 22.1% 4 Kingsoft Antivirus 82 4.1% 5 360 Safebox 80.8 -9.4% 6 Rising Antivirus 46.3 -4.1% 7 Kingsoft PC Doctor 41.5 -3.7% 8 Rising Personal Firewall 17 N.A. 9 360 First-aid Kit 10 N.A. 10 Kingsoft Web Shield 9.7 -52.5% 450 400 80% 350 300 60% 250 200 40% 150 100 20% 50 0 0% 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 Source: Company Data, Yuanta Research Source: iResearch (1H12), Yuanta Research Figure 4: Qihoo’s smartphone user base Figure 5: 71.7% of smartphone users prefer Qihoo for 450 mobile antivirus products mn 80% 400 71.7% 70% 350 60% 300 50% 250 36.7% 40% 200 150 30% 100 20% 50 10% 8.3% 7.2% 9.1% Kingsoft NQ Others 0% 0 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 Source: Company Data, Yuanta Research Qihoo Tencent Source: iiMedia, Yuanta Research Monetization of search and mobile games will accelerate in 2014F After the company’s channel PC/mobile antivirus products helped its platform products (search engine and app distribution platforms) establish their positions in the search engine and app distribution platform markets, Qihoo began to monetize them in 1Q13. Qihoo’s search engine contributed sales of US$5/15/27.7 mn in 1Q13/2Q13/3Q13, accounting for 4.6%/9/9%/14.8% of total revenue. However, monetization of its search engine is still at an early stage. According to CNZZ, Qihoo had a 21.7% share of search traffic in November 2013, but accounted for just 1.6% of total search We expect the company to account for 30% of search traffic in 2015 and 5.2% of search engine revenue engine revenue in 3Q13 based on iResearch’s estimate, as its keyword system is not yet mature and it still needs to establish its advertising network. Taking the US search market as an example, Yahoo and Bing had around of 22% search traffic and 19.4% of search engine revenue in 4Q12, and we expect Qihoo to achieve a similar share of search traffic and search engine revenue when its technology, keyword system and sales network mature. Management said their keyword system and sales network will be improved by 2H14. We expect the company to account for 30% of search traffic in 2015 and 5.2% of search engine revenue. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 3 of 27 Figure 6: PC search traffic in China Baidu 90% Qihoo Figure 7: Search revenue market share Sogou & Soso Qihoo others Sogou & Soso Google Baidu 100% 80% 90% 70% 63.6% 80% 60% 70% 50% 60% 40% 80.6% 81.4% 81.4% 4.7% 0.3% 4.6% 0.8% 4.5% 1.6% 1Q13 2Q13 3Q13 50% 21.8% 30% 40% 20% 30% 10% 20% 0% 10% Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 0% Source: CNZZ, Yuanta Research Source: iResearch, Yuanta Research Figure 8: Page view market share in US Figure 9: Search ad market share in the US % 90 Google Google Yahoo! bing Others Bing & Yahoo 100% 80 90% 70 80% 18.0% 18.6% 18.1% 18.5% 19.4% 82.0% 81.4% 81.9% 81.5% 80.6% 4Q11 1Q12 2Q12 3Q12 4Q12 70% 60 60% 50 50% 40 40% 30 30% 20 20% 10 10% 0% 0 -1008-07 09-03 09-11 10-07 11-03 11-11 12-07 13-03 Source: State Counter, Yuanta Research Source: eMarketer, Yuanta Research According to iResearch, China’s mobile game market revenue will increase at a 37.0% CAGR from 2012-15F, and we expect the market size of mobile games will exceed PC based games in 2017 given more potential users and as they are more attractive to female players. Qihoo has the leading app distribution platform in China with around 25% market share in September, and is one of the most important mobile game publishers in China. We expect the company to continue to be the second largest mobile game distributor in China behind Tencent’s (700 HK; HOLD-OPF) Weixin, and will continue to benefit from the fast growth of mobile games in the years to come. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 4 of 27 Figure 10: Mobile app distribution platform time spent Figure 11: Mobile games market size forecast 23 RMB bn Feature phone Smartphone 21 Qihoo 25% Others 34% 19 17 CAGR: 37.0% 15 12.4 13 8.2 11 Baidu 21% MIUI 3% Wandoujia 17% 7 5 Source: iResearch (September 2013), Yuanta Research 4.7 9 1.9 6.8 7.6 7.9 6 2012 2013F 2014F 2015F Source: iResearch, Yuanta Research estimates Focus on user experience and product innovation CEO Hongyi Zhou has always been focused on user experience and product innovation. Qihoo’s business model is to acquire a vast user base via free popular products, and make money from online advertising clients and cooperation of mobile game companies. The company pays attention to user experience in order to be the dominant player in antivirus products. It also develops lots of simple products/apps to make users’ PC/handset operate smoothly and quickly get information from users on their PC/mobile internet habits. Figure 12: Qihoo’s innovative products Innovative products Function Desktop Search Box Users do not need to open a browser to search, just press the “Ctrl” button twice then can search information. 360 Keyboard Qihoo’s customized keyboard to promote its desktop search box. 360 Mobile Safe Intercept crank calls and junk SMS. 360 Mobile Assistant Grants smartphone users the right to uninstall pre-installed apps. Yingshi Daquan Users can search mobile videos from different video platforms. Children Guard Lets parents can monitor their children. Source: Yuanta Research Figure 13: Qihoo’s desktop search box Figure 14: Yingshi Daquan Source: Yuanta Research Source: Yuanta Research Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 5 of 27 Figure 15: Qihoo’s customized keyboard to promote Figure 16: Qihoo’s wearable products for children the desktop search box Source: Yuanta Research Source: Yuanta Research Management efficiency Qihoo has a relatively “flat” management structure, with more than 400 small teams Qihoo has a relatively “flat” management structure reporting to the CEO directly if they have good business ideas. This has helped the company develop many popular products such as Leidian, Yingshi Daquan, its desktop search box with a workforce of less than 5,000. Its employees are also well rewarded, with a positive working environment. We view the management structure as efficient, which can be seen in examples such as the 360 Mobile Assistant, which although it launched four years after 91 Wireless, surpassed 91 Wireless to be the number one Android app distribution platform within two years thanks to the favorable user experience and strong channel advantage via its 360 Mobile Safe product. Qihoo launched its search engine in August 2012 and already has a 21.7% share of search traffic in November 2013, thanks to its popular internet browsers. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 6 of 27 Valuation Our 12-month target price of US$115 is derived from the average of our DCF valuation and our PEG-derived fair value estimates. We believe our valuation captures both the short-term and long-term earnings potential of the company, as well as the stock’s relative valuation. Our target price implies 52.4x 2014F P/E. DCF analysis Our forward DCF estimate is US$121.8 We derive a forward DCF estimate of US$121.8. Our valuation is based on the assumptions of a cost of equity of 14.5%, and a terminal growth rate of 3% for the period after 2030. Our forward DCF estimate implies a P/E of 55.5x. Our DCF assumes China’s online advertising market will develop in a similar fashion to the US market, where paid searches account for the bulk of the online advertising market. We expect paid searches to be driven by further penetration of search marketing among Chinese SMEs, and continued increases in the number of Chinese consumers adopting e-commerce. We assume Qihoo will take some of Baidu’s share, and China’s mobile game market is still at an early stage and Qihoo will be the second largest mobile game operators in the coming years. Relative valuation analysis For relative valuation analysis, our PEG-derived value estimate is US$107.1, based on 1.0x PEG, implying a P/E of 48.8x derived from our 2014F EPS estimate. Qihoo’s Our PEG-derived value estimate is US$107.1 P/E ratio is much higher than its peers because in our view Qihoo is only at its early stage of its monetization and is doing well in the search engine and mobile game markets. Figure 17: Qihoo’s 12-month forward P/E 250 Figure 18: Qihoo’s PEG ratio 1.6 US$ 1.4 200 1.2 1.0 150 0.8 100 0.6 0.4 50 0.2 0 Source: Bloomberg, Yuanta Research 13-10 13-07 13-04 13-01 12-10 12-07 12-04 12-01 11-10 11-07 Source: Bloomberg, Yuanta Research Yuanta China: Internet Software & Services 11-04 13-10 13-07 13-04 13-01 12-10 12-07 12-04 12-01 11-10 11-07 11-04 0.0 Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 7 of 27 Figure 19: EPS CAGR for 2013-15F Figure 20: P/E vs. EPS CAGR for 2013-15F 120% 4.5 104.7% Amazon 4.0 100% 3.5 80% 3.0 2.5 Tencent 60% 2.0 40% 1.5 33.1% 25.3% 19.60% 20.1% 20% 12.7% 15.5% eBay 1.0 13.4% Facebook Baidu Google NetEase Qihoo 0.5 0.0 0% 0% Qihoo Tencent Baidu NetEase Google Facebook eBay 20% 40% 60% 80% 100% 120% Amazon Source: Bloomberg, Yuanta Research Source: Bloomberg, Yuanta Research Figure 21: Peer valuation comparison table P/E Name Qihoo Ticker QIHU US Rating Share price ROE Mkt Cap (mn) PEG 2013F 2014F 2013F 2014F BUY 79.9 10,176 54.9x 36.4x 0.7 24% 30% 700 HK HOLD-OPF 474.6 882,557 40.8x 35.7x 2.1 33% 28% Baidu BIDU US HOLD-UPF 173.2 59,038 33.2x 25.6x 1.7 35% 30% Sina SINA US Not rated 78.5 5,232 82.3x 38.2x 2.3 4% 9% NetEase NTES US Not rated 69.8 9,116 12.3x 11.0x 0.9 25% 23% Youku YOKU US Not rated 29.6 4,912 -66.9x 149.6x N.A. -5% 3% GOOG US Not rated 1,077.3 359,909 24.5x 20.6x 1.4 18% 18% FB US Not rated 49.4 123,048 59.6x 44.2x 2.0 14% 14% eBay EBAY US Not rated 51.4 66,503 19.3x 16.6x 1.3 15% 15% Amazon AMZN US Not rated 382.2 174,941 155.4x 82.9x 4.2 8% 8% China's internet peers Tencent Global peers Google Facebook Source: Company data, Bloomberg, Yuanta Research Note: Figure s are denominated in local currency, latest update on December 12, 2013; Qihoo, Baidu and Tencent’s figures are from our estimates, while other companies’ data are from Bloomberg consensus. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 8 of 27 Earnings outlook Qihoo’s monetization of its traffic is still at an early stage, especially for its search engine and mobile games. We expect its leading position in PC/mobile antivirus products will continue, and its search engine market share will grow from 1.6% in 3Q13 to 5.2% in 2015. In terms of app distribution platform, competition with Baidu will intensify, but we believe Qihoo will maintain its leading edge in the coming years. However, Tencent’s Weixin will compete in mobile games, and we see Weixin as more competitive than Qihoo’s 360 Mobile Assistant. Overall, we estimate revenue of US$664/1,053/1,423 mn in 2013-15F, implying a CAGR of 62.9%, while we expect net profit of US$174/262/401 mn, implying a CAGR of 104.7%. Figure 22: Qihoo’s revenue breakdown Online advertising 1,600,000 IVAS Others Figure 23: EPS assumptions EPS (L) YoY (R) 250% US$ k 2.5 YoY (R) 300% US$ 2.3 200% 1,200,000 250% 2.0 1.8 150% 200% 1.5 1.3 800,000 100% 150% 1.0 100% 0.8 400,000 50% 0.5 50% 0.3 0 0% 2011 2012 2013F 2014F 2015F Source: Company Data, Yuanta Research estimate Yuanta China: Internet Software & Services 0.0 0% 2011 2012 2013F 2014F 2015F Source: Company Data, Yuanta Research estimate Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 9 of 27 Revenue breakdown Rapidly growing internet user base China’s search market will benefit from a growing internet user base, while increasing user sophistication and internet content volume should also boost search demand. According to the CNNIC, total China internet users have grown at a CAGR of 21.8% over the past five years to 564 mn at the end of 2012. Nevertheless, the Chinese internet penetration rate of 42.1% at the end of 2012 was still much lower than the 70% and above in many developed economies. Figure 24: China’s Internet population and penetration Internet user(L) mn 140% Internet penetration(R) 800 700 60% 120% 50% 100% 600 40% 500 Figure 25: Global Internet penetration rate (2012) 126% 115% 86% 82% 80% 78% 78% 75% 60% 400 30% 38% 40% 300 20% 20% 200 10% 100 0 0% HongKong South Korea 2015F 2014F 2013F 2012 2011 2010 2009 2008 2007 2006 2005 0% Source: CNNIC, Yuanta Research estimates France UK Japan US Germany China Source: International Telecommunications Union We see room for further growth in the internet user base in China in the coming years, driven by rising PC penetration and continued upgrades in broadband infrastructure. Based on our estimates, internet users will likely grow at a CAGR of 6.6% to 684 mn by the end of 2015 with an internet penetration rate of 49.6%, which is at the lower end of internet penetration rates for developed economies. Search engine business Search user base and search advertising customers will continue to grow Driven by rising internet users and more internet content, the search user base has been growing in tandem with China’s internet market. Search remains the second most popular internet application among all Chinese internet users. The number of search users increased from 407 mn in 2011 to 470 mn in 1H13, and we expect this number to rise further to 659.5 mn by the end of 2015. More SMEs will increase budgets for online advertising, especially for search advertising. According to CNNIC, 23% of SMEs would have liked to place internet adverts in 2012, while 53.2% prefer search advertising. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 10 of 27 Figure 26: China’s internet users and search users 800 mn Search users (L) 60% YoY (R) 700 50% 600 40% 500 400 30% 300 20% 200 10% 100 0 0% 2004 2006 2008 2010 2012 2014F 2016F Source: CNNIC, Yuanta Research estimates Figure 27: SMEs favor internet adverts most (2012) Figure 28: SMEs prefer search & IM advertising (2012) 0.5% Others 3.4% Others Handset Radio 4.1% 4.1% Online v ideo 16.3% Forum/BBS 16.4% Internet ads Union 16.4% SNS 8.3% Magazine 10.8% Outdoor 17.9% 20.2% Weibo 23.0% Internet Display 44.3% Email 44.5% 50.0% E-commerce 11.5% New s paper 51.6% IM 6.4% TV 0% 5% 53.2% Search 10% 15% 20% 25% Source: CNNIC 0% 10% 20% 30% 40% 50% 60% Source: CNNIC Search usage still relatively low While the search user base is growing rapidly, search usage in China is still relatively low. According to comScore, China’s monthly average searches per user was only 66.8 in 2011, much lower than in developed countries and also lower than some developing countries such as Vietnam and Indonesia. We expect search demand will continue to grow along with increases in internet content and rising numbers of internet users going forward. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 11 of 27 Figure 29: Monthly average searches per user by area Figure 30: Monthly average searches per user by (2011) country (2011) 160 160 144.7 140 113.4 109.5 120 96.9 89 100 136.9 140 126.2 126.2 125.6 122.7 120 100 80 91.4 85.8 79.2 80 72.1 66.8 60 60 40 40 20 20 0 Worldw ide Asia Pacific Europe North America Latin America MidEastAfrica Source: comScore, Yuanta Research 0 China Japan India Korea Taiwan Vietnam Indonesia HK Singapore Source: comScore, Yuanta Research Online marketing will be more popular going forward, due to rising internet users and marketing demand from SMEs. Since search advertising has higher ROI and lower fund entry barriers, we expect paid advertising as a proportion of total internet advertising will increase from 49.8% in 2012 to 56.7% in 2015F. We estimate paid search revenue will be RMB38.8/50.7/63.4 bn, implying a CAGR of 31.2% over 2012-15F. Figure 31: China’s online advertising proportion is on Figure 32: China’s online advertising revenues the rise RMB bn 500 450 Online adverts (L) China adverts (L) As % of China adverts market (R) 400 350 300 250 Internet adverts market size (L) YoY (R) 40% RMB bn 200 90% 35% 180 80% 30% 160 70% 25% 140 20% 60% 120 50% 100 200 15% 150 40% 80 30% 10% 60 50 5% 40 20% 0 0% 20 10% 100 2007 2009 2011 2013F 2015F 0 0% 2006 Source: iResearch, Yuanta Research estimates Yuanta China: Internet Software & Services 2008 2010 2012 2014F Source: iResearch, Yuanta Research estimate Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 12 of 27 Figure 33: China’s online advertising breakdown Others Paid search revenue (L) RMB bn 70 100% 73.4% 38.8 38.4% 40 50% 30% 30.6% 11.0 25.0% 20% 10% 0% 0 2010 29.5% 29.7% 33.1% 56.5% 56.7% 49.8% 55.0% 7.0 2009 10% 40.9% 5.0 2008 30% 38.3% 18.9 20 10 40% 28.1 30 40% 50% 0% 2015F 50.5% 60% 48.5% 2014F 60% 61.4% 61.1% 58.7% 20% 50.7 2011 70% 43.0% 36.1% 35.0% 35.3% 80% 70% 58.6% 50 80% 63.4 71.1% 60 90% YoY (R) 2013F Display 2012 Paid search Figure 34: China’s paid search revenue forecast 2008 2009 2010 2011 2012 2013F 2014F 2015F Source: iResearch, Yuanta Research estimate Source: iResearch, Yuanta Research estimate Search engine market share to continue to rise Qihoo entered the search engine market in August 2012, and accounted for 21.7% of total China search traffic in November 2013, supported by its popular browser/navigation site and desktop search box. Baidu (BIDU US; HOLD-UPF) continues to have advantages over Qihoo, with better technology, a keyword system, its Baidu Union platform, and greater sales capability. We believe Qihoo will need around two more years to perfect its search engine, but expect it to take some market share from Baidu in the years to come. Qihoo accounted for 1.6% of total paid search revenue in China in 3Q13, with only Baidu will remain the leader in the Chinese search market, but Qihoo may gain market share 12-13% of advertisers willing to place adverts on its searches, according to Adsage. Similar to the situation in the US, where Google remains the search engine leader despite Bing taking some market share, we expect Baidu will remain the leader in the Chinese search market, but Qihoo may gain market share. Figure 35: Search engine industry chain Typing URL Brand Paid links Paid links Favorites Paid links Searcher Browser Organic results Organic results Advertiser Organic results Organic results Navigation Site Organic results Channel App/software/ Desktop search/toolbar Source: iResearch, Yuanta Research Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 13 of 27 Figure 36: PC search traffic in China Baidu 90% Qihoo Figure 37: Search revenue market share Sogou & Soso Qihoo others Sogou & Soso Google Baidu 100% 80% 90% 70% 63.6% 80% 60% 70% 50% 60% 40% 80.6% 81.4% 81.4% 4.7% 0.3% 4.6% 0.8% 4.5% 1.6% 1Q13 2Q13 3Q13 50% 21.8% 30% 40% 20% 30% 10% 20% 0% 10% Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Source: CNZZ, Yuanta Research 0% Source: iResearch, Yuanta Research We believe Qihoo’s keyword system, sales network and technology will mature going forward, and as such expect its search traffic will increase, rising to 30% of China’s total traffic by 2015F. Given an increased search traffic market share, the company is likely to attract more online advertisers, and as a result its click through rate (CTR) and cost per click (CPC) should increase. We estimate search engine revenue of US$88.3/279.7/536.9 mn in 2013/14/15F. Figure 38: Search engine business forecast 1Q13 2Q13 3Q13 4Q13F 1Q14F 2Q14F 3Q14F 4Q14F 2013F 2014F 2015F Search users from PC (mn) 451 470 489 508 527 546 565 584 508 565 659 average monthly search times per user from PC 68.0 68.5 69.0 69.5 70.0 70.6 71.1 71.6 69.5 71.6 72.0 Qihoo's market share (%) 13.5% 15.3% 18.2% 23.0% 24.5% 26.0% 27.0% 28.0% 23.0% 28.0% 30.0% Qihoo's queries (mn) 10,758 13,609 16,609 21,418 25,822 28,668 31,378 33,918 62,393 119,785 155,822 0.5 0.9 1.1 1.2 1.2 1.2 1.3 1.3 0.9 1.2 1.5 1.00% 1.00% 1.05% 1.05% 1.07% 1.09% 1.11% 1.14% 1.03% 1.10% 1.19% Paid clicks (mn) 50.0 125.2 192.5 260.7 330.2 385.1 442.9 502.9 628 1,661 2,762.3 Cost per click (US$) 0.10 0.12 0.14 0.16 0.16 0.16 0.17 0.18 0.14 0.17 0.19 Revenue from PC search traffic (US$ k) 5,000 15,000 27,724 40,542 52,893 63,544 75,263 88,035 88,266 279,735 536,899 958% 324% 172% 117% 217% 92% Average advertisements per query Click through rate YoY Source: Company Data, Yuanta Research estimate Website navigation business Qihoo launched its website navigation page at the end of 2009 in order to leverage its significant traffic and user base. The service surpassed Baidu’s Hao123, the leader in China’s website navigation segment for ten years, to become the largest website navigation operator in China from 2011, thanks for its popular browsers (25.3% market share as of October 2013) and better user experience. The company provides key outside internet traffic for a lot of major internet players, such as Taobao, Youku, and Sina. The business model for website navigation is to charge advertisers a monthly fee to provide paid links for clients, and also guide users to clients. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 14 of 27 Figure 39: Browser market share (October 2013) Figure 40: Mkt share for website navigation in China Others 2% 2345 12% Chrome 5% Others 11% Qihoo 38% Safari 7% Sogou Browser 6% Microsoft IE 46% Sogou 17% 360 Browser 25% Hao123 31% Source: CNZZ, Yuanta Research Source: CNNIC(Nov. 2013), Yuanta Research The website navigation market is already mature, with the competitive landscape likely to remain stable in the years to come. We expect Qihoo’s website navigation business will continue to grow, and estimate website navigation revenue of US$329.8/408.7/415.9 mn in 2013/14/15F, a CAGR of 23.4%. Figure 41: Website navigation business forecast 1Q13 2Q13 3Q13 4Q13F 1Q14F 2Q14F 3Q14F 4Q14F Average daily clicks on the 360 Personal-Start-up Page (mn) Days of this quarter Total clicks of this quarter (mn) 489 590 681 744 778 796 806 810 90 91 92 92 90 91 92 92 44,010 53,690 62,652 68,450 70,060 72,478 74,122 74,550 ASP per k click 1.33 1.41 1.48 1.50 1.30 1.38 1.45 1.47 Website navigation(US$ k) 58,400 75,600 92,976 102,868 91,109 100,014 107,797 109,796 YoY 28.6% 48.8% 59.2% 53.8% 56.0% 32.3% 15.9% 6.7% 2013F 2014F 2015F 626 798 816 365 365 365 228,802 291,210 298,005 1.44 1.40 1.40 329,845 408,715 415,902 48.9% 23.9% 1.8% Source: Company Data, Yuanta Research estimates Gaming business Qihoo charges users for web and mobile games. We believe the webgame business Qihoo was the number two webgame operator in China in 3Q13 has already entered a mature stage, and estimate the market size CAGR will fall to 23% in 2012-15F, down from 63% in 2009-12. Some webgame developers transformed into mobile game developers in 2013, such as IGG (8002 HK; NR), Kingsoft (3888 HK; NR). The webgame business model is positive for operators, as they can retain around 70% of game revenue. Qihoo was the number two webgame operator in China in 3Q13 with 12% market share. We believe it will maintain its advantages as competitors enter the mobile game segment. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 15 of 27 Figure 42: Webgame market size Webgame market size (L) 16 Figure 43: Webgame operation and payment model YoY (R) Webgame developers Around 30% webgame revenue 35% RMB bn 14 30% 12 25% 10 Revenue sharing Game content & update 20% 8 Webgame operators Around 70% webgame revenue 15% 6 10% 4 2 5% 0 0% Game content & update Payment Other player services 2012 2013F 2014F 2015F Webgame players Source: iResearch, Yuanta Research Source: Yuanta Research Figure 44: Webgame market share in 3Q13 Yaowan Xunlei 4% 7K7K4% 4% 91Wan 5% Tencent 38% Baidu 5% YY 5% 4399 11% Qihoo 12% 37Wan 12% Source: Source: iResearch Figure 45: Top 10 web games in China by daily search Ranking Game Operator No. of Searches (k) 1 Pindldea Qihoo/4399 Game/37Wan/51Game/91 88 2 Arcade in Three Kingdoms Qihoo/4399 Game/Baidu/7K7K/37WAN /91Wan/51Game 85 3 Tribal Guards Battle Tencent 80 4 DDtank Qihoo/4399 Game/Baidu/7K7K/51Game 66 5 Killers of the Three Kingdoms 4399Game/Baidu/Shanda 52 6 Genesis Soul 4399 Game/7K7K 40 7 Blood King Someday Qihoo/4399 Game/7K7K/91Wan/37Wan 40 8 Qiang Hun Qihoo/4399 Game/7K7K/91Wan/37Wan 34 9 Ao Jiang 7711/Juu/Zhengwu 33 10 Qi Xiong Zheng Ba Tencent 32 Source: Baidu Index of Dec 9 2013, Yuanta Research Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 16 of 27 Mobile game segment to continue to see fast growth The mobile game market has grown significantly in China since 2013, with an increasing number of users accessing the internet via mobile devices, such as We expect time spent on mobile apps to exceed time spent on websites on PC by 2Q14F smartphones and tablets. According to iResearch, a research firm focused on the internet market, time spent on mobile apps has increased at a fast pace, with internet users spending 35.3% of their time online using mobile apps as of March 2013. We expect time spent on mobile apps to exceed time spent on websites on PC by 2Q14F. Figure 46: China‘s smartphone population to be 500 Figure 47: China’s mobile internet penetration to mn in 2013F increase to 40.7% in 2013 mn 800 700 Smartphone population(L) YoY (R) 710 640 150% 140% 570 600 500 500 400 360 300 80% 160% 120% 500 100% 400 80% 200 40% 80 14% 12% 11% 0 20% 0% 2010 2,011 2012F 2013F mn Mobile Internet User(L) Penetration(R) 37.8% 45% 40.7% 40% 420.0 35% 30% 25% 300 20% 60% 39% 200 100 600 2014F 2015F 2016F 15% 200 10% 100 5% 0 0% 2H06 2H07 2H08 2H09 2H10 2H11 2H12 2H13F Source: iResearch, Yuanta Research Source: CNNIC, Yuanta Research estimate Figure 48: Increasing numbers of people access the Figure 49: Time spent on mobile applications vs. PC internet by handset websites 600 Desktop Notebook Handset Mobile APP 500 100% 400 90% 80% 300 55.7% 70% 64.7% 59.7% 72.7% 60% 78.7% 200 50% 40% 100 30% 20% 0 2H09 1H10 2H10 1H11 2H11 1H12 2H12 1H13F 2H13F Source: CNNIC, Yuanta Research 35.3% 40.3% 27.3% 10% 21.3% 0% 3Q12 1Q13 PC w ebsite 52.7% 50.2% 47.7% 44.3% 47.3% 49.8% 3Q13F 1Q14F 45.7% 43.7% 52.3% 54.3% 56.3% 3Q14F Source: iResearch, Yuanta Research Since more and more users will access internet via mobile devices, we expect mobile game market size will exceed the client-based game market eventually. Key trends which benefit the development of mobile games include: 1) the 1.22 bn mobile users in China as of October 2013, vs only 591 mn internet users in 1H13, according to CNNIC and MIIT; 2) only 27% of PC game users are female, but there are 33.8% female mobile users, while 18.8% of female game users would pay for games, vs. 17.5% of male game users, according to iiMedia; 3) young people prefer to play online games on their PC, while older people prefer to play mobile games, but older people have higher payment ability. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 17 of 27 Figure 50: PC-end gamers by gender Figure 51: Mobile gamers by gender Female, 27% Female, 33.80% Male, 66.20% Male, 73% Source: Analysys international, Yuanta Research Source: iiMedia, Yuanta Research Figure 52: PC-end gamers by age Figure 53: Mobile gamers by age >36, 2.0% >40, 11.5% 31-35, 13.2% <15, 14.1% <18, 37.0% 36-40, 7.0% 31-35, 8.6% 16-20, 20.0% 26-30, 18.3% 25-30, 11.5% 21-25, 32.4% 18-24, 24.4% Source: iResearch, Yuanta Research Source: iiMedia, Yuanta Research Based on our channel checks, there are more than 1000 mobile game developers in China and more than 8000 mobile games will have been launched by the end of 2013, with more developers and mobile games to be added in 2014. According to iResearch, China’s mobile game market size will be RMB20.3bn by 2015, implying a 2012-15F CAGR of 37.0%. Figure 54: Mobile game market size 23 RMB bn Feature phone Figure 55: Online game market breakdown Smartphone Client-based games 90% 19 CAGR: 37.0% Social games 12% 14% 16% 18% 2012 2013F 2014F 2015F 70% 15 12.4 13 60% 50% 8.2 11 40% 4.7 9 5 Mobile games 80% 17 7 Webgames 100% 21 1.9 30% 6 6.8 7.6 2012 2013F 2014F 7.9 20% 10% 2015F Source: iResearch, Yuanta Research Source: iResearch, Yuanta Research Yuanta China: Internet Software & Services 0% Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 18 of 27 Similar to client-based and webgames, mobile game developers need to cooperate with publishers/operators with channels to access mobile users. There are three major channels, pre-installation, app distribution platforms and Weixin; the latter two are popular mobile game channels. Tencent (700 HK; HOLD-OPF) selects mobile games to operate in its Weixin and mobile QQ channels, while most mobile game developers are willing to cooperate with app distribution platforms. Qihoo has the largest China android app distribution platform, with android devices accounting for 65.98% of China’s total smartphones in 3Q13. According to iResearch, Qihoo accounted for 25% of time spent on mobile app distribution platforms in September 2013. Figure 56: Competition landscape of app distribution platform Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Qihoo 38.4 39.1 42.7 44.2 46.4 46.7 47.7 48.2 52.8 Baidu 37.5 36.5 39.9 37.4 39.4 41.7 44.0 45.3 41.9 Wandoujia 27.2 28.8 29.2 26.7 29.3 27.1 29.4 29.2 31.1 MIUI 10.0 10.1 11.5 10.3 10.6 10.7 11.8 13.7 13.8 Qihoo 13.9 11.7 16.5 12.1 12.7 12.0 14.0 12.4 12.6 Baidu 8.8 8.8 8.4 8.8 8.5 8.7 10.2 12.0 10.4 Wandoujia 3.7 4.1 4.9 4.9 5.3 4.4 4.3 6.5 8.5 MIUI 1.2 1.0 1.2 1.4 1.4 1.1 2.0 1.5 1.7 Total 38.9 40.8 46.5 46.6 46.4 44.6 47.8 50.1 50.5 Qihoo 35.7% 28.7% 35.5% 26.0% 27.4% 26.9% 29.3% 24.8% 25.0% Baidu 22.6% 21.6% 18.1% 18.9% 18.3% 19.5% 21.3% 24.0% 20.6% Wandoujia 9.5% 10.0% 10.5% 10.5% 11.4% 9.9% 9.0% 13.0% 16.8% MIUI 3.1% 2.5% 2.6% 3.0% 3.0% 2.5% 4.2% 3.0% 3.4% Mobile app distribution platform monthly unique visitors (mn) Mobile app distribution platform monthly time spent (mn hours) Mobile app distribution platform monthly time spent market share Source: iResearch, Yuanta Research Since there is a debate whether Qihoo or Baidu is the largest mobile game operator via app distribution platform, we have checked four popular games launched on both Qihoo and Baidu’s platform. We found that Qihoo contributed more than 30% of revenue of the four mobile games total revenue, while Baidu contributes around 20%, which leads us to believe Qihoo still has some advantage over Baidu on mobile game distribution. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 19 of 27 Figure 57: Revenue source of “I am MT” Others, 30% Figure 58: Revenue source of “The legend of King” Qihoo, 30% Others, 33% Xiaomi, 10% UCweb, 8% Qihoo, 36% Xiaomi, 7% UCweb, Baidu, 22% Baidu, 18% 6% Source: Game to look (up to June) Source: Game to look (up to June) Figure 59: Revenue source of “Fishing Joy” Figure 60: Revenue source of ”Plants & Zombies” Qihoo, 30% Qihoo, 30% Others, 40% , , UCw eb, 6% , Others, 70% Baidu, 19% Wandoujia , 5% Source: Game to look (up to June) Source: Game to look (up to Sept) Qihoo operated more than 500 games (including webgames and mobile games) in 3Q13, increasing by 230 games QoQ, of which we estimate most were mobile games. The company acquired 590 k paying users in 3Q13, and we expect it to have 1.07 mn paying users by the end of 2015. We estimate Qihoo’s game business revenue will be US$197.4/292.3/382.8mn in 2013-15F, and estimate a CAGR of 65.7% for 2012-15F. Figure 61: Qihoo’s game business forecasts Paying users of Qihoo's game platform (k) 1Q13 2Q13 3Q13 4Q13F 1Q14F 281 440 560 590 670 2Q14F 3Q14F 4Q14F 2013F 2014F 2015F 710 780 870 590 870 1,066 YoY 102.2% 197.3% 207.7% 147.9% 138.4% 61.4% 39.3% 47.5% 147.9% 47.5% 22.5% QoQ 18.1% 56.6% 27.3% 5.4% 13.6% 6.0% 9.9% 11.5% ARPU (US$) 131.0 110.7 96.8 97.8 98.7 93.8 95.7 97.6 477 400 395 YoY 5.2% -14.2% -14.1% -14.5% -24.6% -15.3% -1.2% -0.2% -1.6% -16.0% -1.2% QoQ 14.6% -15.5% -12.6% 1.0% 1.0% -5.0% 2.0% 2.0% Revenue (US$ k) 36,800 48,700 54,200 57,675 66,150 66,594 74,623 84,898 197,375 292,265 382,791 YoY 112.7% 155.0% 164.4% 112.0% 79.8% 36.7% 37.7% 47.2% 134.7% QoQ 35.3% 14.7% 0.7% 12.1% 13.8% 32.3% 11.3% 6.4% 48.1% 31.0% Source: Company Data, Yuanta Research estimate note: mobile game ARPU began to decline in 2Q13 because Qihoo just started to calculate mobile paying users in 2Q13 Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 20 of 27 Company structure Qihoo was founded in June 2005, and the listed company was incorporated in the Cayman Islands and operates its onshore entities via wholly-owned subsidiaries and affiliated entities. The company is based in Beijing, China. Figure 62: Corporate structure Qihoo 360 Technology (Cayman Islands) 100% 100% 100% 360 International Development Co. (Hong Kong) Qihu 360 Software Co. Limited (Hong Kong) 100% Qiji International Development (Hong Kong) 100% Qifei International Development (Hong Kong) 100% Qizhi Software (Beijing) Co.Ltd 100% Tianjin Qisi Technology Co. Ltd. 30% Qifei Xiangyi (Beijing) Co.Ltd 70% Beijing Qichuang Yousheng Keji Co. Ltd Beijing Star World Technology Co. Ltd. (PRC) Beijing Qihu Technology Co. Ltd. (PRC) Eleven Other VIEs (PRC) Source: Yuanta Research Qihoo’s mgmt has around a 39.3% stake in the company, as it offers employees stock. Venture capitalists hold a 37.1% stake. Some profit taking by venture capitalists may be the reason that Qihoo’s share price has fluctuated recently. We believe core management is stable. Hongyi Zhou, Xiangdong Qi and Shu Cao, have cooperated for many years which should help strengthen Qihoo’s execution. Figure 63: Qihoo’s shareholding structure Others 23.6% Hongyi Zhou 17.7% Xiangdong Qi 9.5% Trustbridge Partners 5.4% Shu Cao 4.9% Sequoia Capital China 5.4% Neil Nanpeng Shen 5.4% Young Vision Group 8.6% Global Village 17.7% Other management 1.8% Source: Company data, Yuanta Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 21 of 27 Figure 64: Executive Directors a brief introduction Name Hongyi Zhou Age 43 Xiangdong Qi 49 Position Brief-introduction CEO Mr. Zhou is a co-founder of Qihoo 360 and has served as chairman and CEO since 2006. Mr. Zhou has over ten years of managerial and operational experience and China's Internet industry. Prior to founding Qihoo 360, Mr. Zhou was a partner at IDG Ventures Capital from September of 2005. Mr. Zhou was CEO of Yahoo! China from January 2004 to August 2005. In 1998, Mr. Zhou founded www.3721.com, a company engaged in internet search and online marketing business in China, and served as chairman and CEO until www.3721.com was acquired by Yahoo! China in January 2004. President Mr. Qi is a co-founder of Qihoo 360 and has served as director and president since inception. prior to founding Qihoo 360, Mr. Qi served as vice president of Yahoo! China from January 2004 to August 2005, where he was responsible for Yahoo! China's operations and marketing. From August 2003 to January 2004, Mr. Qi was the general manager of www.3721.com, responsible for its overall operations and strategic planning. Mr. Qi worked at Xinhua News Agency from 1986 to March 2004. Shu Cao Mr. Cao has been the director of Qihoo 360 since 2006 and served as chief engineer since October 2005. Prior to joining Qihoo 360, Mr. Cao served as the chief engineer of Yahoo! China from November 2003 to September 2005 and was responsible for 38 Chief Engineer system operation and maintenance. Mr. Cao has extensive experiences in software engineering, information and technology infrastructure and system operation. Mr. Cao was the co-founder of www.3721.com and served as its head of operations from January 1999 to August 2003. Jue Yao 40 Alex Zuoli Xu Xiaosong Shi 45 43 Co-CFO Ms. Jue Yao has been Qihoo 360's co-CFO since 2012 and VP of finance since 2008. Ms. Yao served as financial director from 2006 to 2008. Prior to joining Qihoo in 2006, Ms. Yao held various positions at Sohu.com from 1999 to 2006, including financial director, where she was responsible for its strategic planning, budgeting and finance of wireless value-added and gaming business units. From 1996 to 1999, Ms. Yao was a senior auditor at KPMG. Co-CFO Mr. Xu has been CFO since February 2011. Mr. Xu has extensive experience in investment research and business management. Prior to joining Qihoo, Mr. Xu was a managing director at Cowen & Company, LLC, and investment banking service provider, from August 2010 to February 2011. From March 2010 to August 2010, he served as the CFO of Yeecare Holdings, a private health care product distributor in China, and from May 2008 to march 201, as the chief strategy office of China Finance Online Co, Ltd., a Chinese Nasdaq-listed online financial information/service company. Prior to that, Mr. Xu was a senior VP at Brean Murray, Carret & Co, a research-driven investment and merchant bank. He was part of a top-ranked research team at Bank of American Securities, LLC from 2003 to 2007, and was an equity research associate at BUS from 2002 to 2003. VP Mr. Shi has been our vice president of Technology since 2006. From January 2004 to August 2005, Mr. Shi was the chief technology officer of Yahoo! China, where he was responsible for technology research and development. From 1999 to 2003, Mr. Shi was the chief technology officers of www.3721.com, a company engaged in Internet search and online marketing business in China. From November 1998 to August 1999, Mr. Shi was a project manager at Founder Group, a leading Chinese information technology company. Mr. Shi received his Ph.D. and Master's degrees in computer science from Xi'an Jiaotong University in 1998 and 1995, respectively. Source: Company Data, Yuanta Research Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 22 of 27 Risks to our recommendation ► Changes in the PC and mobile internet industries happen very fast, there is the possibility that Qihoo may miss the next big trend. ► Large internet names are eager to form alliances to compete in the mobile internet era. Qihoo has some strong competitors, and it will be hard for it to become a first-tier internet player (such as Baidu, Tencent and Alibaba) without strong partners. ► Qihoo has been affected by lawsuits with other internet players, such as Tencent and Baidu. There is the possibility Qihoo could lose one of these lawsuits, which may slow the monetization of its search engine and mobile games. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 23 of 27 Balance Sheet Year as of Dec (US$ mn) Cash & ST investment Profit and Loss 2011 2012 2013F 2014F Year to Dec (US$ mn) 2015F 344 383 1,198 1,539 2,021 0 0 0 0 0 17 24 48 76 102 Inventories Accounts receivable Others Sales Cost of goods sold Gross profit 2011 2012 2013F 2014F 2015F 168 329 664 1,054 (19) (33) (84) (124) 1,423 (161) 149 296 580 930 1,262 14 29 56 88 118 (18) (66) (94) (128) (230) 374 435 1,302 1,702 2,241 Operating profit 131 233 487 802 1,033 LT investments 16 101 101 101 101 Interest income 3 7 5 4 4 Net fixed assets 17 126 132 148 174 Interest expense 0 0 0 0 0 Others 4 Current assets 17 27 43 60 76 Other assets 50 254 276 309 351 Total assets 424 690 1,577 2,012 2,592 Accounts payable 6 7 11 18 23 ST borrowings 0 0 0 0 0 Others Operating expenses Net interest Net Invst.Inc/(loss) Net oth non-op.Inc/(loss) Pretax income 40 197 224 370 508 Income taxes 47 204 236 388 531 Net profit Long-term debts 0 0 600 600 600 Others 6 8 14 22 30 6 8 614 622 630 Total liabilities 52 211 850 1,011 1,161 Paid-in capital 179 180 182 182 182 Capital surplus 186 274 348 360 390 Retained earnings 6 24 198 460 861 Capital adjustment 0 0 0 0 0 371 478 728 1,002 1,433 Shareholders' equity 7 5 4 (2) (1) 0 0 (107) (174) (291) (478) (534) Net extraordinaries Current liabilities Long-term liabilities 3 (1) 0 (5) 0 0 0 25 58 200 327 502 (11) (11) (27) (66) (101) 16 47 174 262 401 1,080 EBITDA 136 249 515 839 EPS (US$) 0.13 0.40 1.45 2.20 3.36 EPS (US$) Bonus Adj. 0.13 0.40 1.45 2.20 3.36 Source: Company data, Yuanta Key Ratios Source: Company data, Yuanta Year to Dec 2011 2012 2013F 2014F 2015F Growth (% YoY) Cash Flow Year to Dec (US$ mn) Net profit Depr & amortization Change in working cap. Others Operating cash flow Capex Change in LT inv. Change in other assets Investment cash flow Change in share capital Net change in debt Other adjustments 2011 2012 2013F 2014F Sales 191.1 96.0 101.9 58.7 Op profit 211.9 77.1 109.0 64.7 28.8 EBITDA 212.0 83.9 106.4 62.9 28.8 Net profit 2015F EPS 35.0 83.4 199.6 271.9 50.7 53.1 (63.7) 197.9 267.2 50.9 53.1 16 47 174 262 401 4 17 28 37 47 Profitability (%) 15 135 (19) 93 86 Gross margin 88.7 90.0 87.4 88.2 88.7 Operating margin 78.3 70.8 73.3 76.1 72.6 EBITDA margin 80.8 75.8 77.5 79.6 75.9 Net profit margin 9.3 14.2 26.2 24.9 28.2 47 (81) 74 (6) 12 82 118 257 386 546 (18) (69) (28) (48) (66) (1) 1 0 0 0 ROA 5.7 8.3 15.3 14.5 17.4 (16) (15) (12) (12) (13) ROE 8.3 11.0 28.8 30.3 33.0 (35) (84) (40) (60) (79) Stability 233 0 0 0 0 0 2 600 15 15 Gross debt/equity (%) 0.1 0.0 82.5 59.9 41.9 Net cash (debt)/equity (%) 92.4 80.0 82.2 93.7 99.2 0 0 0 0 0 Int. coverage (X) N.A. N.A. N.A. N.A. N.A. Financing cash flow 233 2 600 15 15 Int. & ST debt cover (X) 55.3 N.A. N.A. N.A. N.A. Net cash flow 281 36 817 341 482 Cash flow int. cover (X) N.A. N.A. N.A. N.A. N.A. 467 Cash flow/int. & ST debt (X) 178.9 N.A. N.A. N.A. N.A. Free cash flow 47 34 217 326 Source: Company data, Yuanta Current ratio (X) 8.0 2.1 5.5 4.4 4.2 Quick ratio (X) 8.0 2.1 5.5 4.4 4.2 (343.5) (382.7) (598.0) (938.5) (1,420.8) 3.16 4.05 6.10 8.40 12.01 P/E 600.9 201.7 54.9 36.4 23.8 P/FCF 197.4 278.5 44.0 29.3 20.4 P/B 25.3 19.7 13.1 9.5 6.7 P/EBITDA 69.1 37.8 18.6 11.4 8.8 P/S 55.9 28.7 14.4 9.0 6.7 Net debt (US$ mn) BVPS (US$) Valuation Metrics (x) Source: Company data, Yuanta Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 24 of 27 Appendix A: Important Disclosures Analyst Certification Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. Qihoo (QIHU US) – Three-year recommendation and target price history 103 103 93 93 83 83 Share Price US$ 73 73 63 63 53 53 43 43 33 33 23 23 13 13 Mar-11 No. Sep-11 Date Mar-12 Closing Price (A) Sep-12 Target Price (B) Adjusted Target Price (C) Mar-13 Rating Sep-13 Analyst Source: Bloomberg, Yuanta Research Notes: A = price adjusted for stock & cash dividends; B = unadjusted target price; C = target price adjusted for stock & cash dividends. Employee bonus dilution is not reflected in A, B or C. Current distribution of Yuanta ratings Rating Buy HOLD-OPF HOLD-UPF Sell Under Review Restricted Total: # of stocks 144 80 60 12 44 6 346 % 42% 23% 17% 3% 13% 2% 100% Source: Yuanta Research Ratings Definitions BUY: We have a positive outlook on the stock based on our expected absolute or relative return over the investment period. Our thesis is based on our analysis of the company’s outlook, financial performance, catalysts, valuation and risk profile. We recommend investors add to their position. HOLD-Outperform: In our view, the stock’s fundamentals are relatively more attractive than peers at the current price. Our thesis is based on our analysis of the company’s outlook, financial performance, catalysts, valuation and risk profile. HOLD-Underperform: In our view, the stock’s fundamentals are relatively less attractive than peers at the current price. Our thesis is based on our analysis of the company’s outlook, financial performance, catalysts, valuation and risk profile. SELL: We have a negative outlook on the stock based on our expected absolute or relative return over the investment period. Our thesis is based on our analysis of the company’s outlook, financial performance, catalysts, valuation and risk profile. We recommend investors reduce their position. Under Review: We actively follow the company, although our estimates, rating and target price are under review. Restricted: The rating and target price have been suspended temporarily to comply with applicable regulations and/or Yuanta policies. Note: Yuanta research coverage with a Target Price is based on an investment period of 12 months. Greater China Discovery Series coverage does not have a formal 12 month Target Price and the recommendation is based on an investment period specified by the analyst in the report. Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 25 of 27 Global Disclaimer © 2013 Yuanta. All rights reserved. The information in this report has been compiled from sources we believe to be reliable, but we do not hold ourselves responsible for its completeness or accuracy. It is not an offer to sell or solicitation of an offer to buy any securities. All opinions and estimates included in this report constitute our judgment as of this date and are subject to change without notice. This report provides general information only. Neither the information nor any opinion expressed herein constitutes an offer or invitation to make an offer to buy or sell securities or other investments. This material is prepared for general circulation to clients and is not intended to provide tailored investment advice and does not take into account the individual financial situation and objectives of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities, investments or investment strategies discussed or recommended in this report. The information contained in this report has been compiled from sources believed to be reliable but no representation or warranty, express or implied, is made as to its accuracy, completeness or correctness. This report is not (and should not be construed as) a solicitation to act as securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on such business in that jurisdiction. Yuanta research is distributed in the United States only to Major U.S. Institutional Investors (as defined in Rule 15a-6 under the Securities Exchange Act of 1934, as amended and SEC staff interpretations thereof). All transactions by a US person in the securities mentioned in this report must be effected through a registered broker-dealer under Section 15 of the Securities Exchange Act of 1934, as amended. Yuanta research is distributed in Taiwan by Yuanta Securities Investment Consulting. Yuanta research is distributed in Hong Kong by Yuanta Securities (Hong Kong) Co. Limited, which is licensed in Hong Kong by the Securities and Futures Commission for regulated activities, including Type 4 regulated activity (advising on securities). In Hong Kong, this research report may not be redistributed, retransmitted or disclosed, in whole or in part or and any form or manner, without the express written consent of Yuanta Securities (Hong Kong) Co. Limited. Taiwan persons wishing to obtain further information on any of the securities mentioned in this publication should contact: Attn: Research Yuanta Securities Investment Consulting 4F, 225, Section 3 Nanking East Road, Taipei 104 Taiwan Hong Kong persons wishing to obtain further information on any of the securities mentioned in this publication should contact: Attn: Research Yuanta Securities (Hong Kong) Co. Ltd 23/F, Tower 1, Admiralty Centre 18 Harcourt Road, Hong Kong Yuanta China: Internet Software & Services Qihoo (QIHU US) 13 Dec, 2013 Initiation Page 26 of 27 Yuanta Greater China Equities Research - Taiwan Vincent Chen Head of Taiwan Research +886 2 3518 7903 vincent.chen@yuanta.com George Chang, CFA Co-Head of Tech +886 2 3518 7907 george.chang@yuanta.com DC Wang Co-Head of Tech +886 2 3518 7962 dc.wang@yuanta.com Bonnie Chang Head of Non-Tech +886 2 3518 7925 bonnie.chang@yuanta.com Jeffrey Cheng Head of Strategy +886 2 3518 7902 jeffrey.cheng@yuanta.com Andrew C Chen IC Backend, IC Substrate, PCB and LED +886 2 3518 7940 andrew.chen@yuanta.com Dennis Chan PC Components, Handsets +886 2 3518 7913 dennis.chan@yuanta.com Steve Huang, CFA Semiconductors & Display +886 2 3518 7905 steve.huang@yuanta.com Calvin Wei PC/NB, Passive Components, IPC +886 2 3518 7971 calvin.wei@yuanta.com SzuLiang Liu PCB, Connectors, Auto Electronics +886 2 3518 7963 sl.liu@yuanta.com Chuanchuan Chen IC Design +886 2 3518 7970 chuanchuan.chen@yuanta.com Felix Hsu Semiconductor, Solar +886 2 3518 7946 felix.hsu@yuanta.com John Chen TFT +886 2 3518 7933 john.lw.chen@yuanta.com Chia-Wen Yeh Conglomerates and Tourism, Household Durables +886 2 3518 7922 chiawen.yeh@yuanta.com Yvonne Tsai Petrochem/Textile/Medical Devices/Shipping +886 2 3518 7942 yvonne.tsai@yuanta.com Peggy Shih Taiwan Financials, Environmental Eng +886 2 3518 7901 peggy.shih@yuanta.com Peggy Lee Pharmaceuticals +886 2 3518 7984 peggy.lee@yuanta.com Leslie Kuo Autos & Food Staples +886 2 3518 7961 leslie.kuo@yuanta.com Huiyi Chen Property and Building Materials +886 2 3518 7904 huiyi.chen@yuanta.com Robbie Tseng Petrochemicals & Chemicals +886 2 3518 7945 robbie.tseng@yuanta.com Maggie Chi RA - Upstream Tech +886 2 3518 7969 maggie.chi@yuanta.com Sunny Chow RA - Upstream Tech +886 2 3518 7939 sunny.chow@yuanta.com Edward Du RA - Upstream Tech +886 2 3518 7911 edward.du@yuanta.com David Huang RA – Non-tech +886 2 3518 7948 david.sw.huang@yuanta.com Ted Lai RA – Non-tech +886 2 3518 7909 ted.lai@yuanta.com Frank Lin RA – Downstream Tech +886 2 3518 7915 franky.lin@yuanta.com Rainy Wang RA – Upstream Tech +886 2 3518 7916 rainy.wang@yuanta.com Sandy Weng RA – Strategy, Downstream Tech +886 2 3518 7956 sandy.weng@yuanta.com Livia Wu RA – Strategy, Downstream Tech +886 2 3518 7920 livia.wu@yuanta.com Yingyu Wu RA – Strategy, Upstream Tech +886 2 3518 7930 jessie.y.wu @yuanta.com Kelvin Ng Renewable Energy +852 3969 9518 kelvin.kc.ng@yuanta.com Benson Wan Oil & Gas/Industrial +852 3969 9529 benson.cf.wan@yuanta.com Nice Wang China Strategy +86 21 6187 3821 nice.wang521@yuanta.com Research - Hong Kong/Shanghai Peter Chu, CFA Head of HK Research Consumer Research +852 3969 9521 peter.kk.chu@yuanta.com Samuel Kwok, CFA Autos & Machinery +852 3969 9527 samuel.kwok@yuanta.com Sales and Trading John Chang Head of Taiwan Equities +886 2 2175 8898 john.chang@yuanta.com Juan Tseng Head of Taiwan Sales +886 2 2175 8962 juan.tseng@yuanta.com Duncan Wun Head of HK Cash Equities +852 3969 9869 duncan.wun@yuanta.com Tom Hsu Head of Taiwan Sales Trading +886 2 2175 8800 tom.hsu@yuanta.com Jenny Lo Head of HK Sales Trading +852 3969 9769 jenny.lo@yuanta.com Kerry Chen - Sales +886 2 2175 8922 kerrychen@yuanta.com Philip Kong – Sales +852 3969 9879 philip.kong@yuanta.com Jason Lin - Sales +886 2 2175-8998 jason.lin@yuanta.com Michael Lin - Sales +886 2 2175 8977 michael.lin@yuanta.com Leslie Ling – Sales Trading +886 2 2175 8855 leslie.ling@yuanta.com Fiona Tan – Sales +886 2 2175 8921 fiona.tan@yuanta.com Kate Jackson – Sales Trading +852 3969 9767 kate.jackson@yuanta.com Derek Tong – Sales Trading +852 3969 9728 derek.tong@yuanta.com Joyce Wan – Sales +852 3969 9876 joyce.wan@yuanta.com Jason Wang – Sales Trading +886 2 2175 8888 jason.wang@yuanta.com Paula Wong – Sales +852 3969 9832 paula.wong@yuanta.com Sales of Non-Taiwan Equities Franker Lin Head of Foreign Equity Department +886 2 2175 8720 laiochenlin@yuanta.com Lunghui Chen Co-Head of Sales, Foreign Equity Department +886 2 2175 8730 lunghuichen@yuanta.com Oscar Yang Co-Head of Sales, Foreign Equity Department +886 2 2175 8733 oscaryang@yuanta.com