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Why I'm Short Qihoo 360

In advance of its March 2011 IPO, QIHU engaged iResearch to provide a market survey report and provide detailed statistics to quantify QIHU's market presence in China. The report itself was never made public, but references to it are cited heavily in the IPO prospectus including that QIHU:
  • "is the number 3 Internet company in China"
  • "is the number 2 browser company"
  • "is the number 1 Internet and mobile security solutions provider"
  • has an "80%+ user penetration rate in China."
  • Based on these statistics, the IPO was a massive success, trading to over $36 from its IPO price of $14.50 -- an increase of 148%. Since that time, the share price has fallen by 50%, despite astonishing revenue growth.

    For just $300, I was able to engage iResearch to provide me with proprietary data and a one-hour consulting session. The biggest surprise was that iResearch data is compiled using the computers of only around 200,000 paid computer users. That represents about one-half of one-tenth of 1% of the Internet users in China, an absolutely miniscule sample size which ignores 99.95% of the Internet users in China. It is hard for me to understand how such conclusive market statistics could be generated using this sample size or methodology.

    According to CFO Alex Xu, the report cost approximately 10,000 to 30,000 RMB (roughly $2,000 to $5,000). This also struck me as an incredibly small sum given that iResearch is cited 66 times in the IPO prospectus and is effectively the only independent verification of QIHU's market presence. The IPO raised in excess of $200 million and QIHU has a $2 billion market cap which would seemingly justify a more thorough and extensive (and presumably more expensive) due diligence effort.

    My primary goal was to verify the revenue potential of QIHU's website. iResearch initially told me that the price of links on this type of web page should be no more than 100,000 RMB ($16,000) per month. When I pointed out that QIHU discloses an average of 350,000 RMB ($55,000), and sometimes as much as several million RMB, I was told that this simply wasn't possible, but that they would look into it further. They subsequently called QIHU and confirmed what I had said, that QIHU charges much more than the original iResearch estimate.
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