Qihoo 360 Is Committing Fraud — Plain and Simple

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When Citron began to write on Qihoo we had questions but we did not identify Qihoo as an outright fraud.  We understand the liability that exists in calling a publicly traded company a fraud if it is not one, especially one that trades on the New York Stock Exchange.  Until now, we have always left ourselves an out … that has now come to an end.

In writing this column for over 10 years, Citron has learned that any time a “fraud” has an opportunity to explain their business, it is a good thing for a short position.  Yesterday’s conference call was no different, as now the company has stated positions that they cannot take back.

   In the Company's Own Words

Yesterday, in a hastily called phone conference to respond to Citron's last posting, CFO Alex Xu fielded questions in an attempt to quell fears of shareholders and concerns of analysts.  Judge for yourself.  Below are some the highlights of the call in the words of Mr. Xu as he attempted to justify the number advertisers and their claimed rates on their homepage ( hao.360.cn)  Here he explains why so many of the links on Qihoo's home page do not contain tracking links.

Alex Xu statement #1:

Non transaction customers do not need to see the tracking patterns.

Citron Response:

Any customer of Qihoo is presumably buying web traffic, period.  Why would a non-transaction customer buy a link anyway?  Any company seeking branding buys banner or dynamic ads.  As Qihoo stated in their Q2 conference call:

“We are the best at really in Chinese Internet market in terms of advertising results for those e-commerce companies and because we don't do any branding ads or anything like that…”

 

So he is claiming that his customers are buying links because the generated traffic is so great, but have no interest in knowing where the traffic comes from?

 

Alex Xu statement #2:

In China users who scroll over a URL with their mouse and become suspicious of a long link and may decide not to click. So some customers decide not to put it up (eg not to click).  (We swear he said this)

Citron Response:

Every website throughout the world tracks ads and paid links with tracking id's in the links …..duh.  Do you know something Google, Yahoo,  Sina, Sohu, and Baidu don’t know?  Not to mention the tracking id can add as few as 7 or 8 characters (several examples of which are on Qihoo's own site) and Qihoo's user is the most novice of all internet users.

Alex Xu statement #3:

Companies don’t put tracking id into their URL’s in order to enhance the user experience.

Citron Response: 

Does this gentleman, the CFO of a company claiming to be China's 3rd largest internet firm, know how the internet works?  Having a URL with 8 more characters does NOTHING to the “user experience.”  I cannot believe Citron actually had to respond to that statement.

Alex Xu statement #4:

There is confusion in the marketplace because we run such a differentiated business model — either in China or globally.

Citron Response: 

To the contrary, Qihoo's might be the most undifferentiated business model on the internet.   As Citron has shown in previous reports there are literally hundreds if not thousands of web directories in China.  If you just type HAO360.cn or HAO360.com (instead of HAO.360) you will see two examples of hundreds (more than a dozen of which we published URL's for in our prior report) of directories not belonging to Qihoo.  As for globally, there used to be many companies in the US with this business model…..until they all went out of business.

Alex Xu statement #5:

Customers with 2 links pay for both links and Citron only gave them credit for one link. 

Citron Response: 

We are supposed to believe that customers are paying double the rate to have two of the same links on the same exact page….really?  Or triple the rate for 3 links?  Hmmm…..

Alex Xu statement #6:

Qihu 360 has largest and most sticky internet sites in China.

Citron Response: 

How…why?  Qihoo has zero unique content.  Why would your sites be sticky?  In our opinion, just more internet jargon.

   More Qihoo Lies

On the last conference call we are told that their hao.360 website is now more popular than Baidu’s hao123.  The exact quote was:

 “regarding the question on market share. First of all, compared to hao123, both from our internal data as well as from third party data, we already surpassed hao123 in terms of UV as well as the clicks." 

Citron has the Comscore ratings on both sites. 

Comscore compares hao.360 and hao123

For those of you unaware, Comscore is the gold standard of internet ratings.  Its Media Metrix product generates the metrics  upon which all major brand internet advertising globally is priced from… including China.

http://www.comscore.com/Products_Services/Product_Index/Media_Metrix_Suite/Media_Metrix_Core_Reports

From this we see that as of October 2011, Baidu's hao123 directory site is generating 300% — 400% the traffic and reach of Qihoo's.  And for those who say that is not a fair measure, just read Comscore’s methodology from their site where they explain:

comScore’s UDM is unique to the industry and provides a superior solution by overcoming common methodological shortcomings, such as the inability to measure the actual person not just machine, over- or under-counting usage based on cookie deletion habits and misrepresentation based on a multiple usage devices or the same person using multiple browsers.”

http://www.comscore.com/About_comScore/Methodology

So let's get this straight.  We are supposed to believe that companies call Qihoo directly and give them $50,000 USD a month on average (and in many cases multiples of that for multiple links) , all of such customers dealing direct — without an agency,  and without tracking identification?  And furthermore, these customers are accepting ad rate cost increases of 25% each quarter because of a blind auction, again without any verification? … Really?

   "Trust, but Verify" — Ronald Reagan

Someone has to teach the Qihu CFO how to lie better.  Much of the call was that whether it be the traffic or the auction model, QIHU advertisers do not require any verification from the company because they trust them.

That would make QIHU the largest and the only internet company in the world based on trust rather than analytics.

In the real world, the internet is based on analytics.  Unlike advertising on an outdoor billboard, what makes internet advertising so effective for the advertiser is you can actually see what people click on and how to make more effective ad spends.  Google does not provide analytics because people do not trust them, they provide it because THAT IS HOW BUSINESS IS CONDUCTED, ANALYZED, AND EVALUATED IN THE DIGITAL WORLD.

The analysts on this name have it wrong.  They can stand by it just like the many analysts did on Longtop Financial.  We can start highlighting commentaries in the analysts reports, but it is nothing more than a sideshow.  Furthermore, even though Qihoo's gaming revenue reflects ARPU's way out of comparables of their competition, we will make the point on another day.  To stay focused, we are just discussing the largest part of Qihoo's revenue which is the HAO.360 website directory and the advertising revenue it generates.

For those of you who keep saying that Citron does not understand because we live in the United States and not China we offer this link.  Two weeks ago QIHU CFO Alex Xu was on CNBC Asia with Bernie Lo.  After hearing his pitch and apparently being unaware of Qihoo's  market cap, Bernie Lo makes the comment:

“You're not going to be a SOHU — they have way too long of a lead time and diversification in their business that makes you a minnow in their ocean”

http://video.cnbc.com/gallery/?video=3000057575

What Mr. Lo didn’t realize is that even though Qihoo is the minnow, Qihoo's enterprise market cap is already 70% larger than SOHU!  Ridiculous is not the word here. 

If Qihoo had the same market cap as SOHU, the stock would be 11. 

If it traded at the same multiple to revenue, it would be at $4. 

And if it is a fraud, it will trade at 0….you choose your poison.

BTW…we just have to mention that QIHU CFO Alex Xu used to be the CFO of China Finance Online (Nasdaq: JRJC) – a Chinese stock picking and touting site.  When Citron wrote about the company in 2007 as it was trading $30 a share….and today it is $1.85.

For those of you who believe 25% qtr over qtr ad revenue growth (eg 144% year-over-year) is not only credible but sustainable, SINA ad revenue has gone up just 26% year over year, despite owning the hottest web property on the China internet, which is Weibo.   And their ad revenue guidance for 2012 is "cautious".

   Conclusion:

This is fraud plain and simple.   Every component of Qihoo's parabolic revenue growth story is based on company assertions that can't be verified in the public domain, do not align to comparisons with industry competitors, and defy common sense.

When you find such a company in the US or China, especially one with a market capitalization over 2 billion dollars, watch out. 

Cautious Investing to All.