First-quarter profit was not expected, due to a significant increase in operating expenses

Second-quarter earnings outlook weak:

Sohu first quarter revenue of 365 million U.S. dollars (the chain down 5%, an increase of 16% per cent). As research and development spending and sales and management spending soared (mainly on the nasdaq:cyou), Sohu's loss per share in the first quarter (not in accordance with US GAAP) amounted to $1.26, 9% and 24% higher than Wall Street analysts ' average forecasts and Deutsche Bank analysts ' expectations.

Sohu's outlook for second-quarter revenues (up 19% per cent year-on-year) was expected, and the quarterly loss (not according to US GAAP) was expected to be $1, while Wall Street analysts expected a loss of $0.5 per share, meaning Sohu's restructuring spending would not be reduced.

In addition to the inability to predict when the turning point of the game business will come, we also believe that the recent action by the Chinese government against inappropriate content could lead to a loss of growth prospects for Sohu's video advertising and branding advertising revenue. We keep Sohu's stock rating unchanged in "hold".

-Rebuild the gaming business; Sogou's growth is in line with the established trajectory:

Sohu's first-quarter gaming campaign spent 81 million dollars, mainly because the company is reshaping its platform. We expect Sohu to continue to invest heavily in the remainder of fiscal year 2014, as it plans to launch a series of new games in the second half and an upgrade package for "Tianlong eight". Meanwhile, Sogou is still on track to grow, the first quarter revenue amounted to 7 million U.S. dollars (up 78% year-on-year, compared with our previous estimate of 72% growth).

In search of traffic support, we expect Sogou's growth momentum will continue, and its profit margins will be increased by operating leverage.

We expect Sohu's Sogou stock to be valued at $1.5 billion (equivalent to 64% of the group's value), the valuation was based on a 1 time-fold peg (the market growth rate) and a year-on-year growth rate of 74% per cent between 2015 and 2017, which means that, in the expected earnings for fiscal year 2015, Its P/E ratio is 74 times times.

-The Government's enhanced content review is likely to make advertising business face headwinds:

Sohu's brand advertising business was strong again in the first quarter (up 39% per cent year-on-year), mainly because video advertising still has growth momentum. But we expect that the recent government announcement that a specific "inappropriate" content is illegal will have a negative impact on video advertising.

Sohu has differentiated itself from other online video service providers by providing a large number of American and original dramas, but these episodes are under scrutiny. While this government move may not lead to a loss of performance, we expect video service providers to be in disarray in the near future.

-To use the cash flow discount method to calculate the valuation, to arrive at the target price of USD 60, to maintain the "hold" rating:

We expect Sohu's fiscal 2014 and fiscal 2015 to suffer net losses due to recent restructuring measures and investment activities. Therefore, we should use the cash flow discount method to calculate the value of Sohu, rather than the previous use of the classification plus the general method (the use of this method to calculate the target price of 78 U.S. dollars). We believe that the cash flow discount method can better reflect the long-term growth prospects of sohu after fiscal year 2016, so it is reasonable to use this valuation method.

Based on the cash flow discounting method, we set the target price of Sohu to 60 US dollars (23% lower than the 78 US dollars calculated according to the classification plus total method), based on the assumption that the discount rate is 13% and the final growth rate is 3%. We keep Sohu's stock rating unchanged in "hold".

-Adjustment of performance expectations:

We have made the following adjustments to Sohu performance expectations:

1) Maintain revenue forecasts for the 2014 fiscal year, while the 2015 and 2016 fiscal year revenue forecasts are cut by 2% and 6% respectively, reflecting the uncertainty of Sohu gaming business transformation and video advertising revenue growth.

2 we will be in the fiscal year 2014 and 2015 fiscal year Sohu EBIT (pre-tax profit) profit margin (not in accordance with the U.S. General Accounting standards) is expected to cut 4.6% and 4.5% respectively, mainly because of Sohu to promote the new games and products of the expenditure higher than expected;

3) As a result, we expanded by 1.5 times times and 3 times times the estimated net loss of Sohu in fiscal 2014 and fiscal 2015 (not in accordance with US GAAP) respectively. We raised the 2016 fiscal year Sohu profit forecast, mainly because of Sogou NCI (attributable to the net profit of uncontrolled rights) were adjusted.

Risk：

Upside risk: Game business performance is better than expected, game business investment is lower than expected, regulatory and advertising market conditions better than expected.

Downside risk: Government regulation of video content more stringent, game business performance weaker than expected, game business transformation investment higher than expected.