Alibaba Could Be Next Into China Search Market

NEW YORK (TheStreet) -- There's a new rumor out Friday from China that Alibaba Group has agreed to buy Sohu's (SOHU) Sogou search engine in order to take on Baidu (BIDU).

It would actually be a surprise if this happened because the most recent rumors about possible buyers for the Sogou search business named Qihoo 360 ( QIHU) and Baidu. The last rumors about this, from a few weeks ago, suggested a buyer might pay as much as $2.5 billion for the search unit.

Take a step back. Why would someone want to pay $2.5 billion for Sohu's search engine when Sohu's entire market capitalization is $2.5 billion?

The answer is about the Chinese search market and how strategically important this area will be moving forward.

There was a time, several years ago, when Google ( GOOG) was the big dog of search in China. Its search engine results were always exceptionally good.

The problem was the Chinese government didn't like some foreign entity controlling the top spot in a strategic area of the Internet.

After a lot of interference from the Chinese government, Google decided to leave the mainland. This left the Chinese search market to Baidu, which quickly saw its market share post-2008 crash go to over 70%. That post-Chinese withdrawal for Google corresponded to a huge spike up in Baidu's stock price as it soaked up the market share in search.

Yet, since last summer, Baidu has faced increased competition from Qihoo. Qihoo has gone from no market share then to about 12% today.

This has left Baidu in a somewhat weakened state and it has increased the desire of its competitors to see it further weakened. After all, this is China. No one makes fat margins for long before about 100 copycats start showing up to try and get a piece of that action for themselves.

Sohu has had its own search engine in Sogou for several years. It has been pretty steady with about a 10% market share in the space.

That may not seem like a lot now but it would swing Qihoo to close to a quarter of the market. That's why Qihoo was seen as aggressively pursuing the stake. You also had Baidu reportedly in the hunt to keep that important share for itself.

So, now we supposedly have Alibaba on the scene. If a deal does happen, it will likely get announced on Monday morning.

Why does Alibaba want in on the action in search? For several reasons.

Search is highly profitable and Baidu has been living very well for a long time on the profits.

Search can strategically drive more transactions to Alibaba's Tmall and Taobao sites.

With an Alibaba IPO likely occurring before the end of the year, why not strike now and make this deal rather than wait and seeing this valuable asset go back to Baidu or even Qihoo -- with whom Alibaba really doesn't have a strong relationship?

Alibaba has been very active in the course of the last few months as it gets closer and closer to its IPO announcement. First it invested in Sina's ( SINA) Weibo service. Then it bought a minority stake in Chinese map company AutoNavi ( AMAP).

Now, it seems probable that Alibaba is going to be moving into search.

When the IPO filing happens for Alibaba -- of which Yahoo! ( YHOO) still holds a 24% stake -- investors could be very surprised by the power of this Chinese Internet conglomerate.

At the time of publication the author was long YHOO, SOHU, QIHU, SINA and short BIDU.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Eric Jackson is founder and Managing Member of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. In January 2007, Jackson started the world's first Internet-based campaign to increase shareholder value at Yahoo!, leading to a change in CEOs in 2007. He also spoke out in favor of Yahoo!'s accepting Microsoft's buyout offer in 2008. Global Proxy Watch named Jackson as one of its 10 "Stars" who positively influenced international corporate governance and shareowner value in 2007.

Prior to founding Ironfire Capital, Jackson was President and CEO of Jackson Leadership Systems, Inc., a leadership, strategy, and governance consulting firm. He completed his Ph.D. in the Management Department at the Columbia University Graduate School of Business in New York, with a specialization in Strategic Management and Corporate Governance, and holds a B.A. from McGill University.

He was previously Vice President of Strategy and Business Development at VoiceGenie Technologies, a software firm now owned by Alcatel-Lucent. In 2004, Jackson founded the Young Patrons' Circle at the Royal Ontario Museum in Toronto, which is now the second-largest social and philanthropic group of its kind in North America, raising $500,000 annually for the museum. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson.

You can contact Eric by emailing him at eric.jackson@thestreet.com.

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