Posted by: Daniel Vlad on 2009.05.05 13:15 in Daniel

The spin-off and initial public offering of Changyou (Nasdaq:CYOU), Sohu's (Nasdaq:SOHU) MMORPG subsidiary, still doesn't make sense to me, but comments from Sohu's Q1 earnings call put some of my concerns at ease.

Changyou was started two years ago as Sohu's online gaming division, and, by the time of the IPO, Changyou was responsible for more than 50% of Sohu's revenues -- impressive growth for such a short period of time.

True, Changyou's TLBB is a great game, but would it have achieved such impressive success if it didn't have a base of 250 million online users and 17173.com, the number one gaming portal in China, behind it? I seriously doubt it.

The online gaming market in China is extremely competitive, and to be successful in this market you need more than a great game. You need scale.

The only other company whose gaming division achieved impressive success in a short period of time is Tencent (700.HK), driven by its 900-million-user strong QQ instant messaging platform.

So if scale and ability to cross-sell are such important success factors in China's online gaming market, why did Sohu spin-off its gaming business? And most importantly, will the two companies continue to work together as effectively as before?

Time will tell, but, for now, it looks like they at least have identified this symbiosis as an important strategic objective. In respective Q1 earnings reports both Changyou CEO Tao Wang and Sohu Chairman and CEO Charles Zhang were quoted as saying the following:

"Going forward, Sohu and Changyou will continue to enjoy the same synergies as before. Sohu provides Changyou with advertising resources on the Sohu portal and its verticals, especially China’s largest gaming portal 17173.com, marketing and promotion of Changyou’s games through the use of Sohu’s web domains, single user-ID system and base of more than 250 million users, as well as Sohu’s strong brand recognition and user platforms. Meanwhile, Changyou continues to bring users to Sohu portal."