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Why I'm Short Qihoo 360

Stocks in this article: QIHU

The list of links on QIHU's webpage includes China's biggest banks, Internet companies and e-commerce giants, all of which would be expected to normally delegate this type of process to an outside ad agency as part of their normal advertising spend. But with QIHU, apparently these companies are forced to call up individually to sign and renew contracts each quarter. From a practical standpoint, this does not seem possible either for the advertisers who must do the work themselves or for the marketing department which does not seem staffed to handle this type of volume.

As I discussed the staffing issue with the CFO, he noted that due to increasing traffic, QIHU is able to simply notify clients each quarter of the price increases and that clients readily accept. The past threee quarters have seen QIHU report roughly doubling the price of its links despite the significant challenges which are facing its advertising clients.

The chart below shows U.S.-listed companies with links on QIHU's page and where they are vs. their 52-week high share price. These are some of the companies which are presumably accepting a doubling of prices this year without a fight. And the price, according to QIHU, can be as high as $1.5 million per quarter for a single link on their page. Once again, this does not seem possible to me in the current difficult environment.

Clearly, there are a number of issues at QIHU which I feel are cause for significant concern. First, QIHU claims to have a near monopoly on its products in China, but the data are based on a miniscule sample size which were compiled in a $5,000 report for its $200 million IPO. Second, placing an ad with QIHU was nearly impossible yet QIHU does not rely on ad agencies at all. Third, the prices charged for simple links and the continuing price increases are almost inconceivable given the current environment for Internet companies in China.

Combine these concerns with a sky-high valuation and QIHU seems to be a very safe short over the next few months and as we head into the 20F filing season.

Disclosure: the author is short QIHU.

The author can be reached at comments@pearsoninvestment.com.

Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.

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