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What Sogou’s IPO means for China’s search market

By Rita Liao

Sogou

Chinese internet companies are ready to test American investors’ appetite again. This time it involves a name less familiar to the West: Sogou.

On July 31, the NASDAQ-listed Chinese internet company Sohu.com announced that its search-focused subsidiary Sogou would make a confidential registration filing to the US Securities and Exchange Commission. Sogou’s 39-year-old CEO Wang Xiaochuan later confirmed the news in an internal email (in Chinese), adding that the company has achieved temporary success in the search industry and will step up its artificial intelligence (AI) efforts. TechNode has verified the content of the email with Sogou.

Wang Xiaochuan (left) at TechCrunch China in 2014

Launched in 2004, Sogou runs three core products—software keyboards for smartphones and input software for desktops, plus a browser and search engine. The product categories make up what Wang calls the “three-stage rocket,” each of which serves as a sub-rocket that channels users to the sibling products. Over the years, Sogou has grown steadily but never reached a dominant market position except in their input products, which claim a 71.2% (in Chinese) market share as of November 2016. Still, Sogou’s plan to go for an IPO is worth paying attention to for the company’s proximity to two of China’s “BAT” trio of internet giants: Baidu and Tencent.

Best alternative to Baidu

Since Google shut down its Chinese search engine in 2010, China’s internet users were left with a search market dominated by Baidu alongside a few smaller players. Qihoo 360, the Chinese internet security company which also offers a search service, once gobbled up Baidu’s market share and went public in the US. In 2015, however, Qihoo de-listed from the New York Stock Exchange hoping for a better valuation back home. If Sogou successfully achieves an IPO, it will be the only US-listed Chinese internet company similar to Baidu in terms of having a focus on search as well as a pivot to AI.

Both Baidu and Sogou rely heavily on search revenues. Of Sogou’s $660 million total earnings in 2016, 90% came from search-related services. Baidu still makes much more—$10.16 billion in 2016—than Sogou, but over 91% also came from online marketing, which is synonymous with its auction-based paid search business: advertisers bid for priority ad placement based on key word queries made by Baidu search users.

Online marketing contributed as much as over 95% to Baidu’s earnings from 2012 to 2015 and only toned down after Baidu was ordered to reduce the ads it carried alongside query results following a PR fiasco. Wei Zexi, a 21-year-old college student, died of synovial sarcoma in 2016 after receiving distorted information from Baidu’s poorly vetted medical ads.

Despite the blunders, Baidu continues to lead in search in China. Data by StatCounter, a Dublin-based web traffic tracker, shows that Baidu commands 77.43% of the market, which includes search on mobile, tablet, and PC. Sogou comes in fourth place with 3.73%. Another report by CTR, a Chinese market research joint venture between China International Television Corp (CITVC) and Kantar Group, however, ranks Sogou in second place with a 32.8% market share “in all connected terminals.” The discrepancies in numbers speak to the research firms’ different tracking mechanisms: StatCounter tracks the type of browser used by sending a useragent string to each page view. CTR determines penetration rates based on WEB, WAP and APP numbers aggregation and weighing.

Sogou fairs better in mobile search, an area in which the company has outpaced its competitors in user growth and revenue growth for the past 26 consecutive quarters, said Wang in his internal email. A recent report by third-party research company iiMedia shows that in the first half of 2017, Baidu had a 41.2% market share in mobile search, followed by Sogou at 20.9%.

All of this points to Sogou’s path to becoming the next best alternative search engine to Baidu in China. But focusing solely on search is no longer enough to allure American investors. Like Google, Baidu and Sogou have bet big on artificial intelligence. In fact, both are now calling themselves an “AI company.”

Sogou’s AI robot (Image credit: ZEALER China)

“AI is an enormous opportunity that will revolutionize the internet and traditional industries,” said Robin Li, the engineer-turned-chairman and CEO of Baidu. “Baidu, in particular, is well positioned to lead the AI wave in China, with our unique combination of technology, data, and talent.” Baidu has upped its ante in AI in recent months, from hosting its first global AI developers conference in Beijing to buying smaller AI companies.

Wang, who also comes from a technical background, made a similar statement earlier this year: “In 2016, Sogou strengthened its competitive position through product differentiation and AI-powered technology innovation.” Sogou has been working with Tsinghua University on vertical applications of AI into areas like voice recognition, language processing, mapping, and machine translation. Wang called language the “jewel in the crown,” and trusts that a language-centric development roadmap would make Sogou a leader and innovator in AI.

Tencent’s ally

By many measures, Sogou is not nearly as big as Baidu yet; but Sogou has a mighty ally, Tencent, whose $219.03 billion revenue in 2016 more than doubles that of Baidu. In 2013, Tencent acquired a 40% stake in Sogou and let the latter merge with its search service Soso. Later, Tencent made the content in its WeChat official accounts searchable exclusively via Sogou. Since then much of Sogou’s mobile search growth has come from Tencent, largely driven by Tencent’s QQ mobile browser.

Tencent’s stake in Sogou has risen to 45.37% (in Chinese), outpacing Sohu to become the largest shareholder. However, Sohu remains the de facto controlling shareholder of Sogou as all of its 38.35% shares are class A common shares with voting rights, while over half of Tencent’s are non-voting class B common shares.

This explains why Sogou might have opted for an IPO in the US, as companies with dual-class share structure are banned from listing in Hong Kong and mainland China. A way for billionaire tech company founders to sell shares without relinquishing control, dual-class shares have been adopted by more than two-thirds of the New York-listed Chinese companies, including Baidu and JD.com, according to the Financial Times. It remains unknown how Sogou’s IPO will affect its control structure.

Though WeChat set up a dedicated search application department in April, Sogou will likely remain the only third-party search engine with access to WeChat’s mounting public account content. At the moment, WeChat search pulls content only from within the app, but its access to 938 million monthly active users will become an immediate threat to Baidu, and possibly Sogou, once the search function expands to open web. In Q1 2017, Tencent contributed 40% to Sogou’s mobile search traffic, although that number has gone down, according to Wang (in Chinese). It remains to be seen whether Tencent will cut back on its support for Sogou, and whether Sogou can prove that its next AI technologies are indeed more superior.

Sogou has not announced the number or dollar amount of American depositary shares (ADSs) proposed to be offered and sold. Back in January, Bloomberg reported that Sogou was planning to sell about 10% of its shares in an IPO valued at around $5 billion. Sogou’s spokesperson was tight-lipped on details about the IPO when TechNode inquired.

Source:: What Sogou’s IPO means for China’s search market

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