Chinese Internet portal Sohu.com Inc's shares fell more than 11 percent on Monday, as a 37 percent rise in quarterly net profit failed to impress investors amidst falling gross margins and higher operating expenses.
"Although Sohu's net income has risen in three straight quarters ... the main area of concern seems to be that this is the fifth straight quarter that it saw shrinking gross margins," TD Ameritrade's chief derivatives strategist JJ Kinahan said.
Over the five-quarter period, margins have contracted almost 1.75 percent per quarter on a year-over-year basis, he said.
"The negative reaction in the stock might be a case of 'buy the rumor, sell the news' as the stock had rallied in the weeks leading up to the report. Prior to today's (losses), the shares had gained nearly 37 percent since June 17," said Frederic Ruffy, options strategist at New York-based WhatsTrading.com.
"Some investors might have been anticipating a strong quarter and are banking profits on the news," he added.
At least two analysts said the company's plans to invest heavily in marketing its new game "Duke of Mount Deer" -- an adaptation of a popular novel by Jin Yong -- may further erode margins and hurt third-quarter earnings.
Sohu's multiplayer online role-playing game unit Changyou.com currently operates seven online games in China, including Tian Long Ba Bu, Blade Online and Blade Hero 2.
Sohu forecast third-quarter net income of $1.20-$1.25 per share. Analysts were looking for earnings of $1.18, according to Thomson Reuters I/B/E/S.
"In terms of top line guidance it's ok, but in terms of bottom line, the company plans to spend $10 million to market its new game," TH Capital Research analyst Tian Hou said.
The company is not going to monetize this game until the fourth quarter, while investors were expecting it to monetize the game in the third quarter, Hou said.
RBS analyst Wendy Huang said Sohu's third-quarter outlook for adjusted net profit of $47-$49 million, implies adjusted net margin of 21 percent, down from 23 percent in the second quarter.
The aggressive investment on new game's launch, search and video may erode margins and earnings in the third-quarter, Huang said in a note to clients.
Sohu, which competes with Sina Corp, NetEase.com and Tencent Holdings, expects third-quarter revenue of $225-$230 million, above market estimates of $207.9 million.
Operating expenses for the second quarter rose 37 percent year-over-year on increases in headcount and average compensation, and higher marketing associated expenses.
Quarterly gross margin fell by 1 percent sequentially to 73 percent.
Sohu's second-quarter net income was $42.7 million, or $1.10 per share, compared with $31.3 million, or 82 cents a share in the year-ago period.
Online game revenue for the second quarter were $101.5 million, up 31 percent from the year-ago quarter.
Shares of Changyou.com Ltd, Sohu's majority-owned unit, also fell about 15 percent after it forecast third-quarter adjusted earnings of 95-98 cents per ADS, below analysts' estimates.
Shares of the company, which have shed 18 percent of their value since touching a year high of $109.36 on April 28, were down $10.09 at $80.01 in afternoon trade Monday on Nasdaq. About 3.9 million shares, more than double their normal trading volumes, changed hands by 1320 ET.