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Stock Contenders for China’s Online Search

What can Qihoo do to market leader Baidu?

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The basis of any legal action looks to be based on the “mechanics” of Qihoo’s search engine, which means we might see a claim about proprietary technology or source code being infringed upon. While China has long been accused of being a hotspot for IP theft and piracy, the government recently launched a program designed to crack down on intellectual property violations, so any legal action could have teeth.

Waiting in the Wings

Of course, it would be unlikely in a market the size of China’s that Baidu (and now Qihoo) would have things all to themselves. There are other search engines, although they compete for a very small fraction of the market (combining for under 5% of Chinese search engine revenue). Among these niche operators are Soso, Youdau and Sohu’s (NASDAQ:SOHU) Sogou, the biggest player among this lower-tier of search engines, with roughly 2.4% of the market.

Emerging vs. Mature

Google’s home market — the U.S. — is a mature one when it comes to Internet use. Almost all homes have Internet access of some description, so growth in search revenue is expected to be organic, increasing slowly with population growth and more time spent online. The same holds true for much of its international market as well.

China, on the other hand, has an estimated 815 million people who currently lack Internet access. As this remaining population gains Internet access — and it will — the potential online ad market in China could explode.

And while Baidu has positioned itself to take full advantage of this rapid growth, it suddenly finds that it no longer has the market to itself. The battle for search customers and online ad revenue between Baidu and Qihoo is just beginning, but the stakes are more than 1 billion Internet users (today there are roughly 2.3 billion Internet users worldwide). A company that can sew up this huge surge of new online visitors through its search engine stands to rake in ad revenue and truly become the “Google of China.”

Who Wins?

At the moment, Baidu looks likely to remain on top, but will see its search share cut by Qihoo (unless it can stop it through legal action). According to a Globe & Mail story, in its first week of operation, Qihoo’s search engine cost Baidu between 4 and 8 percentage points of share — a number that could rise to between 15% and 18% later this year.

As a result, Germany’s Deutsche Bank dropped its target for Baidu from $186 to $137. Qihoo shares are up nearly 60% in the past month, and the company has said revenue for the third quarter may hit $82 million, which would be growth of 70%. A surge in one of the other, smaller players (such as Sogou) also is possible, although less likely.

BIDU’s trailing P/E of 30, while expensive, still is half that of QIHU’s, and Baidu seems unlikely to be pushed from the top. Although both companies will see a big boost from growing Chinese Internet use, Baidu — the one that looks to get the lion’s share and become China’s Google to Qihoo’s Yahoo (NASDAQ:YHOO) — is the one I’d stick with.

As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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