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China's Sogou needs to prioritise profit search ahead of IPO: Gadfly

[TAIPEI] Slowing revenue and falling profit don't seem like great conditions under which to pursue an initial public offering (IPO). They certainly wouldn't lend themselves to hopes of a valuation 50-times-earnings valuation.

Welcome to Sogou Inc.

Sohu.com Inc's search engine business lodged paperwork last week for a New York listing of American depositary receipts. Nestled in the filing are some basic financial numbers that allow potential investors a first glimpse of what's really on offer.

In January, Sogou chief executive officer Wang Xiaochuan said the spinoff from Sohu may be valued at US$4 billion to US$5 billion. He told David Ramli of Bloomberg News that growing mistrust in rival search provider Baidu Inc would help drive his business.

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That's quite a stretch. China's leading search provider certainly suffered from setbacks last year as users and regulators cried foul over a series of medical advertisements. But data from Sogou's filing show that monthly active user and revenue growth are both slowing, while operating profit is also going in the wrong direction.

Even bottom-line growth looks weak. Six-month net earnings for the period through June climbed 41 per cent, according to Sogou's filing. At that same growth rate, full-year net would come in at around US$79 million, a figure still 20 per cent below 2015 takings.

It's important to note the relatively robust growth in the first half came from a lack of one-off items the period prior. Operating profit for the six months ended June 30 was down 27 per cent from a year earlier. 

Sogou first-half operating profit growth -27 per cent. Assuming Mr Wang is still aiming for the lower end of the valuation he spoke of in January, he's going to need to convince investors that slowing revenue and declining operating profit justify a 50-times earnings multiple.

Baidu trades at 37 times estimated 2017 earnings, and that's with analysts forecasting bottom-line growth of 19 per cent this year and 32 per cent next. 

Qihoo 360 Technology Co traded at a price-earnings ratio of 31.8 before getting bought at an equity value of around 53 times last year.

After failing to put much of a dent in Baidu's market share, Sogou is now turning to social media giant Tencent Holdings Ltd, a major shareholder, to ignite growth. This month, Sogou started a trial that integrates its search engine into Tencent's WeChat messenger service.

It's highly possible this will boost usage for Sogou, but it's too early to be sure what the scale of such growth would be, or how much it will actually help the bottom line. Until then, Sogou and its shareholders need to keep up the profit search if they hope to justify any lofty valuation.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

BLOOMBERG