Sohu.com Inc. (NASDAQ: SOHU) is completing the first partial spin-off initial public offering of its Changyou.com (NASDAQ: CYOU).  This IPO will trade today and we are still awaiting the time stamp from NASDAQ.   We had been given a price range of $14.00 to $16.00 per share, and the IPO priced at the $16.00 level for some 7.5 million shares.  There are some solid merits behind this company, and there are some who are very cautious on it.

Changyou.com has a very wide customer base with a very popular product.  MMORPG’s video game dominance in China can be a very profitable arena.  Changyou operates two MMORPG’s, TLBB, and Blade Online. For the three months ended December 31, 2008, Changyou.com had approximately 1.8 million active paying accounts, which game points are utilized for the purchase of virtual items at least once during a given period, for TLBB and approximately 159,000 active paying accounts for BO.

Changyou.com’s revenues grew from $42.1 million in 2007 to $201.8 million in 2008, and its net income grew from $5.3 million to $108.0 million during the same period. For the year ended December 31, 2008, 93.6% of total revenue was attributable to TLBB.

But there is a flip-side to this as well.  No one wants to hear the term “tracking stock” any longer.  Yet that is sort of how this feels.  The spin-off is a partial spin-off.  The amended filing from last week showed that half of the shares being sold for proceeds to go to Changyou.com itself and the other half going to Sohu.com and holders.  There were some reports that the Changyou.com unit raised some $70 to $80 million in recent weeks in Hong Kong. In recent weeks Sohu.com has seen its ratings downgraded at Citigroup, Pali, Oppenheimer, Stern Agee, and a target cut at RBC.

Sohu’s equity interest in Changyou will be reduced from about 84.2% down to about 70.7%.  The reason for noting the “tracking stock” similarity is that Sohu will apparently continue to consolidate all of Changyou.com’s revenues and expenses and there will be a provision for minority interests.  Sohu.com will maintain 81.5% of the voting power via A and B shares assuming that the overallotment is not exercised.  After the offering there will be 15 million Class A shares outstanding and 87.5 million Class B shares outstanding.

The lead underwriters are Credit Suisse and Merrill Lynch (B of A); others listed in the underwriting syndicate are Citi and Susquehanna.  We spoke with a broker in the syndicate last night who was awarded shares.  It looks like there was pre-order demand here, because he did not even get 10% of the shares he requested for clients in the IPO.  There is some interest here in this deal, but it is not without critics.

Jon C. Ogg
April 2, 2009

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