Sohu Seeking Success With Baidu?

Baidu to buy Sogou?

There’s lots to say about word that Internet portal operator Sohu (Nasdaq: SOHU) is selling its Sogou search unit to industry leader Baidu (Nasdaq: BIDU), starting with the strong possibility that this latest in a sudden string of rumors about Sogou may be true. Sogou’s chief executive has already said  publicly the unit was for sale, naming Baidu as one of the leading bidders. The only slight contradiction in the mix comes from comments by Charles Zhang in an interview late last week, which I’ll return to shortly. But first let’s look at the latest reports, which cite an industry source saying Baidu has reached an agreement to purchase Sogou. (English article) The price of the deal looks a bit inflated, with Baidu reportedly prepared to pay between $2.2 billion and $2.5 billion for the deal — about 10 times Sogou’s valuation based on another transaction about a year ago. The price tag also looks inflated because Sohu’s own market value is only $2.4 billion, and its most profitable businesses include its original portal unit along with its separately listed online game unit Changyou (Nasdaq: CYOU).

But the latest report also says that Sohu could receive a big part of its payment by acquiring a controlling stake in Baidu’s iQiyi online video unit. That unit includes iQiyi’s own original service, along with another leading player PPS, which Baidu bought earlier this month for $370 million. (previous post) Assuming iQiyi and PPS are roughly comparable in size, the combined pair would be worth perhaps as much as $800 million or maybe even $1 billion.

Thus an interesting scenario if this report is true might see Sohu and Baidu essentially swap their video and search businesses. That would mean Baidu might take over Sogou’s market share of 5-10 percent to boost its own dominant share of the online search market that now stands at more than 70 percent. Sohu, meantime, would take over Baidu’s video business, which controls 17 percent of the market, with its own online video unit that controls 10 percent to create a sudden major player with 27 percent share. That would rank as the market’s second largest player behind only Youku Tudou (NYSE: YOKU), which has 30 percent.

Of course there are a few reasons why this complex transaction might not be happening, starting with Zhang’s own latest comments that I referenced earlier. In an interview published late last week, Zhang seems to say that Sogou isn’t for sale, saying he is seeking “strategic investment” for the search unit to help it better compete with Baidu. (English article) The same interview also quotes Zhang saying he wants to buy larger video websites to complement his own video service. Where I come from, looking for strategic investor is quite different from selling a unit.

But in this case, perhaps Sohu might sell a majority of Sogou to Baidu and retail a small portion of the unit for itself. Likewise, Baidu could sell a majority of the new iQiyi to Sohu and maintain a minority stake, thereby cementing a complex series of tie-ups between the two companies. Such a tie-up could be part of an ultimate break-up for Sohu that I previously wrote about. (previous post)

While all of this sounds intriguing, one factor that could work against a deal is the anti-trust element, since many have already accused Baidu of having a near monopoly over China’s search market. That means the country’s anti-monopoly regulator could easily veto this deal, throwing Sohu into a state of limbo if it really is placing its bets on a future alliance with Baidu. If the reports really are true, I would expect an announcement as soon as this week, with an interesting period ahead as the market and anti-monopoly regulator react to this newest tie-up in China’s suddenly consolidating Internet space.

Bottom line: Reports of a major tie-up between Baidu and Sohu look credible, potentially boosting Baidu’s lead in search and creating a major new video player.

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