A leading online brand and Internet portal in China, Sohu.com Inc. (SOHU) reported strong second quarter 2010 results.
Earnings, including stock based compensation expense increased 3.8% year-over-year to 82 cents per share, beating the Zacks Consensus Estimate of 80 cents by 2 cents. Earnings exclude Sohu’s non-controlling interest in the online gaming company Changyou.
Revenue
Total revenue was up 15.0% year-over-year and 13.0% sequentially to $146.1 million in the second quarter of 2010, well above the Zacks Consensus Estimate of $143.0 million.
The revenue increase was primarily driven by a strong growth in brand advertising and online gaming revenues, which fully offset the weakness in wireless revenues.
Brand revenues in the second quarter of 2010 escalated 22.0% year-over-year and 35.0% quarter-over-quarter to $53.2 million, while online game revenues increased 17.0% year-over-year and 8.0% sequentially to $77.7 million, primarily driven by a surge in demand for Tian Long Ba Bu (TLBB), Changyou’s flagship game.
Overseas licensing revenues in the reported quarter upped 15% sequentially and 29% year-over-year to $2.1 million.
Online gaming revenues grew on the back of higher active paying accounts (APA) and user base expansion, reflecting the growing popularity of Changyou’s online games. Aggregate registered accounts for Changyou’s games increased 12% sequentially and 42.0% year-over-year to 98.2 million, while APA rose 17.0% quarter over quarter and year-over-year to 2.79 million.
Average revenue per user (ARPU) slashed 8% sequentially and 1.0% year over year. Aggregate peak concurrent users (PCU) for Changyou’s games were approximately 1.14 million, an increase of 21% year-over-year and 25% sequentially.
Wireless revenues fell 26.0% from the year-ago quarter and 17.0% from the prior quarter to $11.1 million.
Gross margin on a non-GAAP basis decreased 400 basis points on a year-over-year basis and 100% basis points on a sequential basis to 74% in the quarter.
Margins were impacted by a lower advertising gross margin, due to a weak result from brand advertising, which was 58.0% in the quarter as compared with 68.0% in the year-ago quarter.
Online game gross margin was 91.0% in the reported quarter, as compared with 93.0% in the prior quarter and 94.0% in the year-ago quarter.
Wireless gross margin inched up 300 basis points year-over-year and was flat sequentially.
Increasing operating expenses was primarily driven by higher marketing expenses. Operating expenses shot up 17.0% year-over-year and 18.0% sequentially to $50.8 million in the reported quarter.
Higher operating expenses had an unfavorable impact on operating margin, which fell 300 basis points sequentially and 400 basis points year over year.
Balance Sheet
As of June 30, 2010 Sohu had a strong cash position of $599.1 million as compared to $563.8 million at the June 30, 2009. At the end of the quarter, Sohu had no debt in its balance sheet.
Outlook
For the third quarter of 2010, Sohu expects total revenue in the range of $153.0 million to $158.0 million. Sohu estimates advertising revenues to be in the range of $61.0 million to $63.0 million.
Sohu expects brand advertising revenues in the range of $57.0 million to $59.0 million and online game revenues in the range of $80.0 million to $83.0 million.
Sohu projects net income on a non-GAAP basis in the range of $39.0 million to $41.0 million and earnings in the range of $1.00 to $1.05.
Recommendation
We believe Sohu’s promising games portfolio and ongoing popularity of Changyou’s games will drive profitability on a long-term basis. However, Sohu continues to face cut-throat competition from Baidu, Inc. (BIDU) and Sina Corp. (SINA). We maintain a Neutral rating on Sohu’s shares.
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