There’s no question that Google (NASDAQ:GOOG) owns the Internet search market in the U.S. and Europe. Despite the best efforts of Microsoft (NASDAQ:MSFT) and its Bing search engine, Yahoo (NASDAQ:YHOO) and even Apple’s (NASDAQ:AAPL) Siri, Google still controls nearly 70% of American search market share. That dominance translates into massive advertising revenue.
However, there’s a huge market that Western companies continue to have problems tapping into: Asia — especially China — dwarfs the U.S. in number of Internet users, and it has a lot more room to grow. It also has its own search engine giants.
News of a new partnership between China’s Qihoo 360 (NYSE:QIHU) and Google hit on Monday, resulting in a better than 7% increase for Qihoo by closing, and continued gains since then (it’s currently up 11% so far this year). The deal has also helped push the Bloomberg China-US Equity Index of U.S.-listed Chinese stocks to a seven-month high.
What’s all the excitement about?
Focused as we tend to be on Western markets, we lose sight of the fact that China already has more Internet users than the U.S. (538 million compared to 245 million) and is poised for rapid and continued growth because only 40% of its population is currently online (compared to 78% in the more mature U.S. market).
American companies would love to gain a chunk of those eyeballs, but it’s tough slogging. Google and Yahoo are struggling, with Yahoo recently announcing it was giving up on South Korea — one of the world’s most wired countries. Google pulled out of China several years ago (moving to Hong Kong after frustration over Chinese censorship laws) and subsequently lost its spot as the default search engine on Qihoo 360’s portal.
Yes, that’s the same Qihoo 360 Google is now partnering with. The Chinese company launched its own Web browser and search engine last August, taking on the leader in Chinese search, Baidu (NASDAQ:BIDU). Often referred to as the “Chinese Google” because of its market dominance, Baidu seemed unassailable. It inked a deal with Microsoft in 2011 to provide English search results via Bing, adding to Baidu’s strength and boosting its market share at that time to roughly 83%.
However, leveraging its position as the country’s largest Internet portal, Qihoo 360 has carved out a sizable chunk of Chinese search, despite being active for only six months. At the end of 2012, Qihoo 360’s share stood at 9.1%, catapulting it into second place in China and showing it to be a credible threat.
Two unanswered questions remain for Qihoo 360, though. Can the company sustain its growth and continue to take market share from Baidu, and can it monetize that search market traffic? Those questions have a big impact Qihoo 360’s potential value as an investment.
New-product launches often start big, then rapidly slow, and Qihoo’s search market share actually slipped a fraction of a percent from its September high of 9.4%. On the other hand, while Baidu missed earnings expectations in its last quarter, Qihoo 360 saw online ad revenue rise 66.5% year-over-year.
Renewing a partnership with Google, this time focusing on Google’s expertise in online ads, is expected to help Qihoo 360 continue to gain market share while further boosting ad revenue. In a Washington Post story about the arrangement, analysts were pointing to continued growth against Baidu along with a $140 million boost in revenue for the year. Considering Qihoo 360’s third-quarter online ad revenues totaled $58.4 million — even after the impressive leap from the previous year — the projected boost from Google would be significant.
While the partnership looks to be good news for Qihoo 360, it should be a positive for the U.S. giant, too. Even though Google would undoubtedly prefer to have its own search engine dominating the Chinese market, having a partnership with the leading alternative (and getting a cut of the ad revenue) is better than nothing. Google shares were up on the news and have gained 4.4% since Monday’s announcement.
Analysts seem to be a little cautious about how things will shake out. Even though a Qihoo 360/Google partnership should be bad news for Baidu, that company’s shares have also been climbing since the announcement. They’re up 7% on the year, at around $105, but that’s still far from last April’s $150. Barrons quoted ABR Investment Strategy as raising its 12-month target price for QIHU from $30 to $32. Given its current $30.75 price and previous lows under $14 at this time last year, this seems like a tepid vote of confidence.
So, don’t expect any spectacular market share gains for Qihoo 360 (after all, Google was its default search previously, when Baidu was even more dominant). But there’s room for modest growth, and Qihoo might even crack 10% of the Chinese search market. Still, now that it’s through its initial release bang, additional gains will be much harder fought and take time.
The bigger value (and more immediate gain) is likely to be increased ability to boost ad revenue — and that’s where the modest stock value growth comes into play.
As of this writing, Brad Moon didn’t own any securities mentioned here.