Qihoo 360 's stock rating was first rated neutral

There is considerable opportunity for Web services, but valuations are not attractive enough; "neutral" ratings

Investment Viewpoint:

Our initial rating of Qihoo 360 was "neutral" and the 12-month target was $66. Qihoo 360 has a unique business model in the global environment, has built its own brand through free security software leading the market, and promises to provide users with a safe and convenient internet experience. Using this brand image, Qihoo 360 created a series of popular network service product combinations, thus generating a large user flow with a circular nature, and then Qihoo 360 sold the traffic to advertisers and game publishers.

We believe that this business model has a high entry threshold. Qihoo 360 's network services have links to each other, and can cross promotions to form a network effect.

Core Growth drivers:

We expect that in the next three years, search and mobile gaming will be the driving force behind Qihoo 360 's revenue growth. Today, the search market has reached $7 billion trillion, the mobile gaming market totals 1.7 billion U.S. dollars, and Qihoo 360 last year revenue of 300 million U.S. dollars, which means the company has the advantage of its product leadership to obtain significant revenue potential. We expect the revenue of Qihoo 360 to grow twice times in fiscal year 2014 and double again by fiscal year 2016.

But we expect this hopeful prospect to induce competition, so Qihoo 360 's profit margin will only slowly expand. In the search market, smaller services tend to have a lower share of revenue than their query request market share, which represents a challenging profit outlook. In the mobile game market, Tencent (0700.HK) micro-letter and Baidu (Nasdaq:bidu) 91 Assistants are major competitors, is expected to drive down the price of the application store products.

Risk：

Upside risk: Profit margin lever of game business; downside risk: execution; competition.

Valuation：

Our target price for Qihoo 360 is based on 1 time times the peg value (the growth rate of the city's surplus). Qihoo 360 has a 41 times-fold earnings ratio based on earnings per share in fiscal year 2014 (not in accordance with US GAAP), and Qihoo 360 is 96 times times earnings per share in the 2014 fiscal year, as predicted by the US general accounting standards. If the profit margin of search business grows rapidly, we think that the implied value of Qihoo 360 is up to $92.

Industry background:

We anticipate a rise in the share of micro-letters in the mobile gaming market, especially in the casual gaming category. (Tangfeng)