SMARTPHONES: Qihoo Calls Early on 2017 with Smartphone Buy

Bottom line: Qihoo’s latest smartphones foray with its purchase of the obscure Blephone reflects the tenacity of founder Zhou Hongyi, but will quickly end in failure due to a late arrival and intense competition in the space.

Security software maker Qihoo 360 just  doesn’t change its mind when opinionated CEO Zhou Hongyi sets his sights on something. After a somewhat disastrous beginning to Zhou’s foray into smartphones over the last 2 years, he’s loudly proclaiming that 2017 will be the year of the smartphone for his company. And to show he’s serious, Qihoo has just revealed that it paid an “eight-digit” figure for an obscure smartphone maker called Blephone.

Industry watchers will recall that the last 2 years have not been good ones for Qihoo in the smartphone space. The company kicked off 2015 with a newly minted smartphone-making joint venture with Coolpad (HKEx: 2369), in what looked like a relatively solid partnership to enter the space. But that partnership quickly went sour over differences between the pair, and Qihoo ended up buying out the venture.

Qihoo is still theoretically making smartphones, even though you never see its products in the market and I have yet to meet anyone who has bought or even seen a Qihoo phone. But Zhou seems intent on developing the space, despite intense competition that has nearly everyone losing big money, with no signs of the pressure easing.

With that background in mind, let’s look at the latest headlines that have Zhou announcing the Blephone purchase on his microblog and proclaiming that 2017 will be his company’s year in the space. (English article; Chinese article) The “eight-figure” sale price means Qihoo is probably getting Blephone quite cheaply, since at a midpoint of 50 million yuan the amount would equate to meager $7 million.

That figure may sound low, but in China’s cut-throat smartphone realm anyone who can get any positive amount of money for such assets is probably lucky. Blephone said in a recent interview it sold 13 million smartphones in the first 3 quarters of this year, and is targeting 20 million for the entire year. It aims to raise that figure to around 30 million units last year. Presumably all of that was before it sold itself to Qihoo.

But regardless, such figures don’t look very impressive to me, especially since they’re quite probably inflated as they’re coming from the company’s chairman and we have no way to verify the information. But the fact that he’s selling his company so cheaply hints that even if he’s selling lots of phones, he’s probably also losing lots of money in the process.

Enter Qihoo into this equation, and I see a recipe for a new disaster. While I don’t have any intimate knowledge of Blephone’s products, I doubt that such a small name has the kind of cutting-edge technology needed to set itself apart from the dozens of other generic smartphones in the market that all look and perform similarly. A look at its website shows most of those phones sell for the equivalent of less than $100, meaning they almost certainly don’t contain any proprietary technology.

Secret Sauce

Qihoo believes it has the recipe for creating a new break-out product in its own smartphone operating system (OS), called 360OS. The latest reports say that Blephone will start installing 360OS in all its phones from next year, meaning its current crop of models, presumably using the Android OS, will be its last.

Zhou shows he’s quite serious about developing the business, saying Qihoo will set up its own smartphone division complete with product development, sales and marketing channel teams. There’s no mention of who is funding this endeavor, which is actually a big issue since Qihoo exhausted much of its financial resources earlier this year with its record $9.3 billion privatization from New York.

Anyone who hasn’t realized by now that I’m highly skeptical of this new endeavor surely doesn’t know how to read between the lines. I have a very healthy respect for Zhou Hongyi, whose privatization of Qihoo from New York earlier this year was a feat that very few people could have completed. Zhou is also quite savvy in spotting the latest tech trends. But in this case he’s really too late to the smartphone bandwagon, and his insistence of pursuing such a path at all costs will ultimately end in disappointment and probably considerable cost to his company.

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