Sogou (SOGO 9.63, -0.70, -6.78%), the second largest online search engine in
China (following Baidu at #1), is trading lower today after reporting Q2
results this morning.
The company debuted as an IPO in November of last year. The search engine was originally conceived in the mid-2000s as a division of Sohu.com (SOHU). Other items numbering among SOHU’s portfolio of online properties in China include the mass portal and online media destination sohu.com and its online gaming property, Changyou.com (CYOU), which also trades publicly. Since before its IPO, Sogou's largest shareholder has been Tencent Holdings (TCEHY).
Powered by AI (artificial intelligence), Sogou Search provides certain services that differentiates it from other search engines. For example, its cross-language search service eliminates the Chinese-English language barrier by enabling users to locate English content on the Internet by querying searches in Chinese and then reading content for which Sogou provides a Chinese translation.
From an industry perspective, more companies in China are using the Internet to expand their businesses and promote their brands. In-line with global trends, advertising spending in China is shifting from traditional media outlets to online advertising. The growth in the online search market in China has also been underpinned by the increased adoption of mobile devices and the rapid ramp-up of mobile search traffic.
Turning to today's Q2 report, non-GAAP earnings per ADS came in at US$0.09, which was better than market expectations. Revenue rose 42.9% year/year to $301.4 mln, which was in-line with prior guidance of $295-305 mln. The Q2 results were decent but not great; of greater issue for the stock’s performance today is the issued Q3 revenue guidance of $275-285 mln, which is well below market expectations.
Why the poor guidance? It seems that Chinese regulatory authorities initiated an investigation of Sogou after certain ads involving content that the authorities believed insulted a martyred national hero were displayed on its platform. The ads were developed and reviewed by Douyin, a popular Chinese short-form video sharing platform, and displayed on Sogou Search in June 2018. Sogou, as instructed by authorities, has taken steps to revise its advertising policies and audit procedures to ensure compliance. As a result of these revisions, Sogou suspended part of its ad business for ten days beginning on July 1. This is expected to result in a one-time reduction in revenue in Q3.
Also, in the interest of product competitiveness, Sogou has decided to phase out hardware products that are not AI-enabled, such as some legacy models of Teemo Smart Watch, and to transition to products that integrate the company's AI technologies. Sogou expects to see this strategic change result in a reduction in hardware revenue in 2H18. So the combination of these two events seem to have impacted near-term revenue outlook.
Despite these issues, Sogou noted that it continued to develop its twin growth engines: search and mobile keyboard. In search, it bolstered services in key verticals, such as healthcare, by adding more authoritative content, leading to a solid increase in related search queries and click-through rate. Sogou also deepened its partnership with WeChat by providing further supplements to its search services, such as an encyclopedia and an interactive Q&A platform. The company also enhanced functionality of the Sogou Mobile Keyboard to better meet user needs for smart interaction and expression. In June, Sogou Mobile Keyboard handled approximately 300 mln voice inputs on average per day, up 54% year/year, and remained China's largest voice mobile app.
In sum, it seems investors are understandably disappointed with the Q3 revenue guidance. is the factors influencing the guidance present a reminder of the investment risks associated with a Chinese company, as the Chinese government can impose impactful restrictions because a national hero was deemed insulted. Hopefully Sogou can turn things around later this year, but it has had a tough ride since its IPO debut in November 2017. The deal priced at $13. After quickly hitting a high of $14.70, the stock went into a steady downturn until spiking higher in June 2018 to $15.50, but it quickly gave up those gains again, and now it's trading a bit above $9.
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