Sohu.com, Inc. (NASDAQ: SOHU) is an Internet services company in China that provides users with news, search, e-mail, games, and wireless messaging on its different web sites. The company monetizes its content and services primarily by selling online advertisements, and markets its products and services to clients mostly in China.
The two core pillars of the company are Online Game and Brand Advertising. In FY 2010, Online Game contributed 53.3% of revenues and 88.2% of income from continuing operations. Brand Advertising accounted for 34.6% of FY 2010 revenues and less than 25% of income from continuing operations (the company did not provide specific figures for each segment).
The company's Online Game segment is conducted by majority-owned Changyou.
The Sohu group reports performance across five segments (Brand Advertising, Online Game, Sponsored Search, Wireless, and Other), but Brand Advertising and Online Game comprised the majority of sales and gross profit from 2006-2010.
Revenue grew +42% YoY to 246 million USD (the upper end of management's earlier estimates). Results vs. management's earlier estimates were as follows:
Gross profit margin was 71% (vs. 74% in Q4 FY 2010). Online Game gross margins fell to 87% vs. 90% in Q4 FY 2010. Online Advertising margins expanded slightly YoY, to 59% from 57% in Q4 FY 2010; Sogou's margins expanded to 65% in Q4 FY 2011 vs. 32% in Q4 FY 2010, offsetting lower margins in Brand Advertising (58% vs 60% in Q4 FY 2010).
Operating profit declined 26% YoY, and operating profit margin fell to 20% vs. 38% in Q4 FY 2010. A major factor in the declining operating profit was a 28 million USD non-cash charge related to goodwill and intangible assets from earlier acquisitions (Sohu's wireless and Changyou's cinema advertising business).
Net income declined 18% YoY to 47 million USD.
Revenue grew +42% YoY, driven by performance in Brand Advertising (+30% YoY growth) and Online Game (+35% YoY). Demand from IT-related companies and real estate firms drove performance in Brand Advertising. Growth in number of players pushed performance in Online Game (the company released an expansion pack, attracting players). The company reported 159 million registered accounts (+51% YoY, excluding 7Road, a Changyou newly consolidated subsidiary), peak concurrent users of 1,150,000 (+17% YoY), active playing accounts of 3,020,000 (+16% YoY), and ARPU at 218 RMB (flat YoY; the company aims to keep the game affordable for players).
Gross profit margin was 71% vs. 74% in Q3 FY 2010. Changes in the way that the company amortized video content in the Brand Advertising segment was the main factor. Specifically, the company noted a change in viewership patterns, and accelerated the amortization. 
Operating profit grew +13 YoY. The company increased headcount and marketing activities in Q3, which increased operating expense +66% YoY.
Net income grew +19% YoY.
The company expected revenues of between 241 and 246 million USD. The company expected Q4 Brand Advertising to be about 78 million USD (about +30% YoY), Online Game revenue of about 124 million USD, and for Sogou's contribution to be about 21 million USD. The company expected Q4 net income of about 72 million USD (non-GAAP).
Revenue grew +36% YoY to 198.7 million USD, led by growth in Online Game (+31% YoY to 101.5 million USD). Brand Advertising revenue grew +27% YoY to 67.7 million USD. Growth in Sogou (the Sponsored Search segment) also contributed, growing +252% YoY to 13.6 million USD.
Gross profit margin was 73%, flat YoY but lower than Q1 (74%). On a YoY basis, margin expansion in Brand Advertising and Sogou (Sponsored Search) were offset by gross profit margin declines in the Online Game and Wireless segments.
Operating profit grew +34% YoY, and operating profit margin was 35% (flat YoY but lower than 36% in Q1). Operating expenses grew +37% YoY, mainly related to increased headcount and marketing expenses.
Net income grew +36% YoY to 61.6 million USD. 
Revenue grew +35% YoY to 174.4 million USD, led by revenue growth in Brand Advertising (+45% YoY) and Online Game (+32% YoY). The Sponsored Search business showed strong YoY growth (+183%) but made a minor contribution in absolute terms (8 million USD). Revenues from Wireless fell -12% YoY to 11.7 million USD mostly because the company stopped promoting its products in March 2011.
Gross profit margin declined YoY to 74% (vs. 75% in Q1 2010). Gross profit margin increased YoY for Brand Advertising, Online Game, and Sponsored Search, but declines in the Wireless and Other segments reduced total gross profit YoY.
Operating profit margin declined YoY to 36% vs. 37% in Q1 2010. Increases in headcount and higher marketing and promotion expense were the main reasons behind the margin decline.
Net income increased +34% YoY to 55.2 million USD.
Sohu operates a number of popular websites to attract users for the company's advertising customers. The company offers some original content and syndicates content from third party content sources (1,600 content partners as of December 2010). The company aggregates both domestic and international content on its sites. Agreements with content providers are typically short term and non-exclusive.
The company offers communication and community-based products for users such as message boards, blogs, micro-blogs, web messenger, and social networking services (SNS, allows users to share discussions, multimedia, etc.).
Services for Advertisers
The company provides advertising "space" across its collection of web properties in text, media, or video formats (ads can be banners, buttons, logos, or streaming advertisements). In addition to purchasing clickable text/button ads, customers can also "sponsor" sections of websites or pages, providing a different level of visibility vs. a text ad. Sponsorship agreements could be considered a more "stable" revenue stream because the payments and contract terms with clients are typically larger compared to non-sponsorship ads. Most customers pay the company a fixed price for a particular amount of advertising time. The company adopted a cost per impressions (CPM, cost per thousand; Roman numeral "M") model in 2010 to cater to different advertisers (especially smaller customers). The company's guideline prices can vary based on specific contract terms and ad locations on the page. Contracts for higher volume and longer terms can include discounts from the standard prices.
The company uses advertising agents and direct sales to sell its ads. In 2010, about 1,800 companies advertised on some of Sohu's web properties. Customers include multinational companies with Chinese operations and domestic companies. The top 5 customers accounted for about 11% of Brand Advertising revenues in 2010.
The company offers seven "massively multiplayer online role playing games", MMORPG, to users. The games include a combination of martial arts fighting and community building (fighting games typically have higher interest upon launch, but shorter lifespans because players get bored; community games take longer to reach a "critical mass" of players, but players typically play longer). All of the company's games operate under the item-based revenue model (play is free, but players typically buy and consume items to enhance game play). The company creates games in-house and also licenses games from third parties.
New Game Pipeline
As of December 2010, the company had several MMORPG games games in its pipeline, including DMD ("Duke of Mount Deer", a game featuring both marital arts fighting and community building in both 2D and 3D modes) and LAW, a martial arts and fantasy game encompassing both modern times and fantasy themes. As of FY 2010, the company's had 989 product development personnel focused on new game development and enhancing existing titles through expansion packs, etc.
The company sells and distributes its prepaid game cards (redeemed to buy virtual merchandise in the game) through direct sales and third party distribution channels. The company sells directly through its online sales platform (players can pay from bank accounts or other online payment systems).
Third party distributors buy the cards directly from the company and then distribute the cards across China. Along with physical cards, the company also offers virtual cards through online channels. The company typically collects payment on delivery, and offers volume discounts . Distributors typically have one year distribution agreements which include pre-set sales and penetration targets. Distributors do not sell the company's card exclusively, but will work with the company's marketing and promotion staff.
The company's sponsored search segment is carried out by subsidiary Sogou (spun off from the parent company in October 2010). The company offers two advertising products in the Sponsored Search segment: priority placement and pay-for-click ads. Priority placement ads are shown at the top of search page results in a shaded area and are larger and more visible compared to the text pay-for-click ads. Sponsored Search contracts are normally for "relatively small amounts" with small and medium-sized enterprises (SME). The ads are shown on the company's website as well as members of its Alliance network.
Sohu's products in the Wireless and Other segments are mostly from the wireless business. The company sells short messaging service (SMS), ring back tone (RBT), wireless application protocol (WAP), multi-media messaging service (MMS), and content (news, weather, chat, entertainment, etc.) to mobile phone customers. Services are delivered through third party mobile network operators, who also handle billing and collections.
Although the company's main businesses, Brand Advertising and Online Game, depend on the size of the overall Internet user population in China, each market can be further defined. For Brand Advertising, the market opportunity could be defined as the total number of users who use a portal as a starting point for browsing the web. The Online Game market can be defined as the portion of Internet users that play games online.
The Internet penetration rate in China (the percentage of the population that uses the Internet) is low by global standards (36% vs. 78% for North America or 58.3% for Europe as of March 2011). It seems reasonable to conclude that China's Internet penetration rate will increase as the economy develops, however its growth trajectory might not necessarily follow other developing countries. The Chinese government regulates many factors that can influence growth in the penetration rate (licensing, regulations targeting content providers for "subversive content", etc.), making government policy a key variable. Considering the lack of transparency surrounding official policy development, it seems that success could hinge on how well a company can predict and respond to the needs of a large but silent stakeholder - the Chinese government.
Although the number of Internet users in China has risen quickly since 2000,  how they spend time online has changed. The number of users playing games online rose from about 120 million in 2007 to about 300 million at the end of 2010, however the YoY growth rate declined from 50% in 2008 to 15% in 2010.  Multiple factors can influence the growth of the online game market, including costs to play, freshness of content, network infrastructure, and demographic trends relating to Internet users.
Several aspects of government regulation can shape the company's competitive position in the market and future prospects. Because the company operates in "sensitive" areas (information and communication), it operates in China through contractual relationships with domestic VIEs which it can't legally own (because the company is incorporated offshore), the legality of which allegedly came into question in 2011. Although the offshore holding company - VIE structure was a popular choice for Chinese companies to raise capital, it remains to be seen if the government will view it favorably in the future.
The Chinese government heavily regulates content in China, a factor which can make the competitive landscape more dynamic than other jurisdictions. Google's problems dealing with the Central Government since the company started doing business in China are well documented.
A major reason that the government can make mapping out the competitive landscape difficult is its lack of transparency in decisions and limited caselaw for existing regulations. The government tightly controls information flow to ensure "social harmony" and can exercise obscure laws with limited precedents to achieve its objectives. Although most of the government's influence in Internet businesses has been limited to foreign firms (like Google), domestic companies can also be impacted. Competitor Baidu.com (BIDU) was subjected to a propaganda campaign by state-run CCTV in 2011 with unclear reasons (possibly signaling increased government involvement in monitoring online content).
SOHU competes with various Internet service providers, including Web directories, search engines, content sites, and sites maintained by the government and educational institutions.
Brand Advertising Competitors
Online Game Competitors