By Perry Wu
With the release of Sohu.com's (SOHU) second quarter numbers this past week, the company's winding path on the road to mediocrity is complete. Gone are the days when Sohu would report increases of 50%, 70%, or 100% on quarter over quarter of revenues. From the tone of Sohu's conference call held this past week, Sohu seems content that its quarter over quarter revenue increase for the current quarter was a mere 9%, not even double digits.

But that is just a small part of this story; the real story is with games. Sohu, the Chinese online portal, has been promoting its online games for several years now, without much success.

But Sohu has found success in other games, the games that it appears to have been playing with its financial statements. Sohu's financial statements show the combined net incomes for the first six months of this year was US$12.8 million. ($5.7 million in the first quarter and $7.1 million in the second quarter). Yet shareholders' equity has hardly budged; it has barely increased US$1 million during the same period.

So on the one hand you have profits of $12 million that should go toward increasing shareholder equity, but shareholders' equity has only moved up $1 million. Something is not quite right. Did Sohu pay a dividend?

No, Sohu has never paid a dividend so the non-increase in shareholders' equity must come from another place. It probably means that Sohu is playing accounting games, using its shareholders' equity accounts to run through expenses that should be run through its profit and loss accounts.

Why should investors be especially concerned? Because now Sohu is obligated to act like an adult. It is not merely equity investors that have a stake in Sohu, Sohu now has real liabilities, real debt. Two years ago, investment bankers managed to convince Sohu to issue long-term debt of US$90 million to investors. The bonds mature in 2023, but, according to the terms of the debt, investors have the option to ask for repayment in 2007, just two short years away. So unlike equity that never legally requires any dividends from a company, debt is an enforceable legal contract. Sohu should not be playing games with its finances–sooner or later it will have to come up with real cash.

Will Sohu have this money? At this point, the answer is yes. Sohu's recent financial statements show that as of June 30, 2005, Sohu's cash balance still stood at US$125 million. But if Sohu continues to play games, and use its cash to acquire dubious companies, then investors may have reason to worry. China Mobile just reinstated Sohu's MMS capabilities after an 11-month suspension. What other government or competitive twists will next throw Sohu's business off-track?

The famous question from the biblical book of Job is, "Where can wisdom be found?", and looking at Sohu's financial statements, I don't want wisdom. I am inclined to instead worry, "Where can cash be found?"

About the author:
Perry Wu is a writer and correspondent for ChinaTechNews.com and can be reached here at the site. Perry Wu does not hold any positions, long or short, on any of the Chinese or American company securities mentioned in this article.