Corporate China

Qihoo sells bonds, still chasing Sogou?

Qihoo's $600 million (HK$4.65 billion) bond sale indicates a purchase of Sogou may be near, helping to boost Qihoo's share of China's search market to 40 per cent over the next two years

PUBLISHED : Sunday, 08 September, 2013, 9:24am
UPDATED : Sunday, 08 September, 2013, 9:25am

Anyone who believes in a bright future for security software maker Qihoo 360 (NYSE: QIHU) will probably say that buyers of $600 million (HK$4.65 billion) worth of newly issued company convertible bonds got a great deal based on the conversion price. The bonds may indeed be a good bargain if Qihoo can come even close to realizing some of the hopes that many investors are holding for the company following its rapid gains into the lucrative online search space formerly dominated by Baidu (Nasdaq: BIDU). The closing of this bond sale looks equally interesting to me, as it could indicate that Qihoo may finally sign a deal to buy Sohu's (Nasdaq: SOHU) Sogou search engine, significantly boosting its search presence after months of protracted negotiations.

Qihoo shares were laggards for the first year and a half after their 2011 New York IPO, as investors questioned its growth prospects and it came under attacks from several short sellers. But its outlook began to improve sharply a year ago following the launch of its search engine, which has gone on to take nearly 20 per cent of China's search market and posed one of the first serious challenges in years to Baidu. Qihoo's American Depositary Shares (ADSs) have soared during that period, rising more than five-fold from their lows of about $15 (HK$116) last August to their current levels of more than $80 (HK$620).

Based on those huge gains in its share price, observers may say investors who purchased Qihoo's newly issued $600 million (HK$4.65 billion) in senior convertible notes got a great bargain. Buyers will be able to convert their debt to Qihoo shares for a conversion price of about $111 (HK$860.9) per ADS when the notes come due in five years. For anyone without a calculator, that means that Qihoo shares only need to rise another 32 per cent from their latest close of $84.20 (HK$653) between now 2018 for bondholders to make a profit from their investment.

Having observed the equally meteoric rise of Baidu's shares after its own IPO in 2005, I'll openly admit that buyers of these new bonds could indeed reap a nice profit from their investment. Qihoo's claiming of 20 per cent of China's search market just a year after the launch of is already an impressive gain, and an acquisition of Sogou would give it nearly a third of China's search market. Monetizing its search traffic is another matter, though that part of the equation seems quite straightforward since Qihoo has shown itself to be quite adept at developing such technologies.

So with this big new wad of cash in its pocket, the more immediate question becomes: Is Qihoo finally near its long-sought deal to acquire Sogou, and what price might it pay? I gave up a while ago trying to predict when this deal might happen, since nothing has ever been announced even though media have reported several times that such a deal was imminent.

I do think that Qihoo founder Zhou Hongyi desperately wants to do this deal, which means he may be willing to pay the high price tag of $2 billion (HK$15.5 billion) or more that Sohu Chairman Charles Zhang probably wants for Sogou. Qihoo could even use its own overinflated shares to help pay for the purchase, which Zhang would probably like since it would allow him to keep an indirect stake in Sogou. I'm not going to make the same mistake as before and predict a closing date for this deal, but I will say that I do think the two sides will eventually reach an agreement. If and when that happens, look for Qihoo to make slower but steady gains in the search market, with its share perhaps topping out around 40 per cent or higher over the next one to two years.

Bottom line: Qihoo's $600 million (HK$4.65 billion) bond sale indicates a purchase of Sogou may be near, helping to boost Qihoo's share of China's search market to 40 per cent over the next two years.

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