Is Tencent the New Darling of Chinese Search?

by Jim Woods | September 17, 2013 2:37 pm

China’s Internet ecosphere is one of the biggest, and potentially most profitable, areas of operation for key players in the space. Mobile gaming, chat and particularly online search are all burgeoning subsectors of China’s massive Internet space … so it’s no wonder why the biggest names in the China web game are continually jockeying for position in an effort to capture Chinese eyeballs.

The latest move to do just that comes from social media and online gaming giant Tencent Holdings (TCEHY[1]). The company just invested the sizeable sum of $448 million for a minority stake in Chinese search engine company Sogou. Now, if that name doesn’t sound familiar to you, don’t worry, you’re not alone. The company isn’t really a huge player in the Chinese Internet search space — at least not yet. It is, however, part of a bigger player in the Chinese Internet ecosphere: gaming and mobile services giant Sohu.com Inc. (SOHU[2]).

According to the terms of the deal, Tencent’s investment of $448 million in cash will give the company a 36.5% stake in Sogou. The terms also include a provision for an increase in the holdings to 40% sometime in the future. Moreover, Tencent’s current search-related business, Soso, will be merged with Sogou.

The infusion of cash from powerhouse Tencent allows the joint venture to take on the two biggest players in the China search space, Baidu (BIDU[3]) and Qihoo 360 Technology (QIHU[4]). Qihoo currently has about 15% of the search market, while Baidu is the clear biggest fish in the space, with 69% of all search traffic, according to industry analytics site CNZZ. Sogou currently has only 9% of total search traffic, but that metric almost certainly is set to go higher as a result of the Tencent deal.

Market reaction following the news saw a nice jump higher in TCEHY and SOHU shares, while BIDU and QIHU shares fell.

The Tencent/Sohu deal is, I think, a particular sting for Qihoo. Earlier this year, Qihoo was in discussions with Sohu to buy a stake in Sogou, but talks dissolved in mid-August, leaving the door open for Tencent.

The fierce battle for market share in the Chinese search sector illustrates the attractiveness of this hugely profitable growth area. For investors looking to benefit from this battle, the latest move by Tencent and Sohu could mean a nice boost going forward for each respective stock.

If you’re looking at things from a wider angle, and if you have a little longer time horizon than just a few months, I think the takeaway from the hunt for Chinese search eyeballs means an underlying bid higher for Baidu. The dominant search firm’s shares are up nearly 400% during the past five years, as investors know that the population metrics and web traffic numbers are solidly in favor of China’s leading search firm. Tencent wants in on this kind of share price performance, and hence its move to acquire Sogou.

The bottom line here for investors, however, is the attractiveness of China’s search business argues in favor of the biggest player in the space, and that player is Baidu. So if you want in on this business boom, BIDU might be your best long-term bet.

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

Endnotes:
  1. TCEHY: http://studio-5.financialcontent.com/investplace/quote?Symbol=TCEHY
  2. SOHU: http://studio-5.financialcontent.com/investplace/quote?Symbol=SOHU
  3. BIDU: http://studio-5.financialcontent.com/investplace/quote?Symbol=BIDU
  4. QIHU: http://studio-5.financialcontent.com/investplace/quote?Symbol=QIHU

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