We are upgrading Sohu.com, Inc. (SOHU) to Neutral from our previous Underperform rating and setting a price target of $65. Strength in the company’s online games and portal business is encouraging. We expect the company to achieve the estimates for 2009 and advise investors to wait for a more favorable exit point.
 
Sohu is the third-largest internet portal and a leading online brand in China. The strength in its online games and portal business are expected to be the strongest drivers for growth beyond 2010.
 
Moreover, Sohu is expected to benefit from China’s growing online advertising industry and expects increased online advertising spending in 2010, reinforced by the World Cup and Asian games.
 
We are encouraged by the company’s growing cash balance as well as its debt free balance sheet. At the end of the third quarter, Sohu had $596.4 million in cash and cash equivalents versus $546.7 million in the previous quarter.
 
While Sohu’s third-quarter earnings beat the Zacks Consensus estimate and have been in line with the company’s own guidance, the outlook for the fourth quarter was much below expectation.
 
Sohu expects total revenues in the range of $134.5 million to $138.5 million, with advertising revenues within the $48 – $50 million range. Brand advertising revenue is expected to be within $45 – $47 million and online game revenues to be in the range of $69 – $71 million. The company expects its net income on a non-GAAP basis to be in the $41.5 million or 78 cents per share to $42.5 million or 80 cents per share range.
 
The company expects additional bandwidth costs and amortized video content costs of $2 million in the fourth quarter as a result of which, operating margin is expected to be slightly depressed. The company’s operating expenses have been going up steadily, which we fear could limit the growth in earnings.
 
Moreover, recent delay in game launches and intense competition from Tencent Holdings, Sina Corp. (SINA), NetEase.com Inc. (NTES) and Baidu, Inc. (BIDU) pose a threat.
 
Sohu’s shares are currently trading at 14.6x our estimate for fiscal 2010 earnings per share, a discounted valuation to its peer group.
Read the full analyst report on “SOHU”
Read the full analyst report on “SINA”
Read the full analyst report on “NTES”
Read the full analyst report on “BIDU”
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