Baidu vs. Qihoo 360: Which Is The Better Chinese Internet Stock For 2015?

By Markets Fool.com

Baidu and Qihoo 360 are the two top search engines in China. Yet the two stocks diverged over the past year, with Baidu rising 29% and Qihoo sliding 25%. Which of course begs the question, what happened to the two companies over the past year, and which stock is a better Chinese Internet play for 2015?

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Jin Mao Tower, Shanghai. Source: Author.

How Baidu and Qihoo 360 are different
Baidu and Qihoo 360 are two fundamentally very different companies.

Baidu is nicknamed the "Google of China" for good reason. Many of its search services, cloud initiatives, portals, and mapping services mirror Google's products. Baidu monetizes them in the same way, through display ads and sponsored links. It even forked Android with its own OS, Baidu Yi, to expand its ecosystem to smartphones and tablets. It has also pursued "moon shots" of its own, like smart chopsticks and smart bikes.

Qihoo 360 expanded into Baidu's backyard after becoming a market leader in free antivirus software. To monetize its user base, Qihoo launched ad-sponsored cloud-based Internet security products, web browsers, and Internet value-added services for third-party games and virtual goods. Qihoo's growing footprint eventually led to the launch of its own search engine, So.com, in 2012, which became the foundation of its cloud-based ecosystem.

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Since then, Qihoo has chipped away at Baidu's market share. Between Aug. 2013 and Aug. 2014, Qihoo's market share in page views soared from 17% to 29%, according to site tracker CNZZ. During that period, Baidu's share fell from 66% to 53%.

Top line comparisons
Last quarter, Baidu's online marketing revenues (which account for 99% of its top line) rose 51.8% YOY to 13.43 billion RMB ($2.19 billion). Its number of active online marketing customers rose 11.2% to 516,000, while revenue per online marketing customer climbed 35.6% to 25,900 RMB ($4,220). Total revenue rose 52% to 13.52 billion RMB ($2.2 billion).

In other words, Baidu's core advertising business was firing on all cylinders despite its loss of market share to Qihoo 360, thanks to its growing customer base and rising revenue per customer.

Qihoo's revenue is split between online advertising and value-added services. Revenue from its search engine, portal sites, and free security products are bundled together under online advertising revenue, which rose 67.2% YOY to $201.9 million last quarter. We should note that although Qihoo's page view market share is roughly half of Baidu's, it only generated 9% as much ad revenue last quarter.

On the bright side, Qihoo's value-added service revenues -- which mainly came from mobile and PC games -- soared 157.7% to $172.8 million. This business, which taps into the $13 billion Chinese gaming market, could eventually become more important than its online advertising business. Qihoo's total revenue more than doubled to $376.4 million during the quarter, continuing Qihoo's streak of posting higher YOY revenue growth than Baidu.

BIDU Revenue (TTM) Chart

Source:YCharts

Bottom line comparisons
As the second place search engine, Qihoo 360 spends more of its revenue on marketing than Baidu. Last quarter, Qihoo spent 24% of its revenue on sales and marketing, compared to 20% for Baidu.

But over the first nine months of fiscal 2014, Qihoo's sales and marketing costs soared 210% YOY, as its product development expenses spiked 64%. This kept Qihoo's margins under pressure -- Qihoo's trailing 12 month operating margin comes in at 13.6%, compared to Baidu's 28.3%. That caused Qihoo's YOY net income growth to slow down -- a bad sign for a smaller "growth" company which only generates a fraction of its primary rival's revenues. Last quarter, Qihoo's net income only rose 30% YOY, compared to Baidu's 27% gain.

Looking ahead into fiscal 2015, things look a tad brighter -- analysts (based on average estimates at Yahoo Finance) believe that Qihoo's EPS could grow 42.5% year-over-year, in comparison to Baidu's forecastof 28% growth.

Future growth potential
Investors that are trying to decide between investing in these two companies should consider two other factors -- mobile growth and basic valuations.

Like the rest of the world, China is shifting away from PCs toward mobile devices. Baidu has made huge progress here -- last quarter, its mobile revenue surpassed its PC revenue and accounted for 36% of its top line. By comparison, Qihoo admits that "search and mobile monetization are in their early stages," and that most of its online advertising revenue still comes from ads on its cloud-based tools and portal sites. If Qihoo fails to effectively monetize mobile platforms, its dominant market share in Chinese PCs (94% in security software, 68% in PC browsers) will become less relevant over time as it relies more on value-added services.

Baidu is a bigger company and posts slower top and bottom line growth than Qihoo 360, but its stock trades at 39 times trailing earnings compared to Qihoo's P/E of 50. Since Baidu's stock is more conservatively balued and the company can still attract high-spending advertisers despite its loss of market share, it seems likely that it is the better bet for 2015.

The article Baidu vs. Qihoo 360: Which Is The Better Chinese Internet Stock For 2015? originally appeared on Fool.com.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Baidu, Google (A shares), and Google (C shares). The Motley Fool owns shares of Baidu, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.