Is Baidu Falling Off The China Cliff?

| About: Baidu, Inc. (BIDU)

Through April of this year, Baidu, Inc. (NASDAQ:BIDU) was one of the hottest tech properties in the investment world. The stock of the leading Chinese language internet search provider reached close to all time highs around $150 and a market value of $55B. Now the stock appears to be falling off the China cliff.

Not only is the stock facing less and less investor appetite for Chinese stocks, but now the fears are growing that all Chinese stocks face delisting possibilities due to audit issues.

While the S&P 500 remained close to recent highs on Wednesday, Baidu again plunged to a new 52 week low. Other issues continue to pop up over the conversion to mobile reducing the click through rate (CTR) and more competition from Qihoo 360 Technology (NYSE:QIHU). All of these issues have pushed the stock down to a very cheap valuation with a PEG near 0.5.

China, China, China

While revenue growth concerns exist, the primary driver of the weak stock action has to be all of the issues in China. Due to lower growth, the China stock market has been very weak. The Shanghai Stock Exchange recently plunged to 3-year lows. Baidu has held up better than the overall China market, but the stock did peak around early 2011 similar to the Shanghai Exchange.

The growth rates at Baidu have helped the stock over come some of the general market weakness, but the recent fears over Chinese auditor conflicts with the SEC and potential delisting can not be overcome.

As Bloomberg reported, U.S. regulators accused the Big Four auditors of refusing to cooperate on fraud probes of China-based companies. Evidently the SEC claims the auditors refuse to provide documentation to the government organization due to Chinese laws banning the removal of corporate records while also not allowing in country access.

The auditor for Baidu is non other than the Ernst & Young Hua Ming, LLP highlighted by the SEC as refusing to cooperate with US regulators. That naturally raises some red flags even if Baidu hasn't done anything wrong.

Mobile Transition

A secondary concern has to be the increased competition especially from the transition to users searching via mobile phones.

In Q3, the company saw 110% year-over-year growth in mobile searches and 25% sequentially. Baidu claims to have a higher percentage of mobile searches though monetization issues continue as with developed markets.

The mobile issues are likely to play out over a couple of years and could easily benefit the company as smartphones open up the market in areas of China where users still don't have adequate PC access.

Qihoo Search Engine

Competitor Qihoo has been on a tear since the company launched its own search engine on August 16th. That stock hit 52-week highs on Tuesday so maybe investors should ignore the Chinese issues and focus solely on competitive threats.

As this article highlights, the company has seen significant growth with apparently no impact to Baidu's market share. In fact, Qihoo has mainly gained from replacing its search engine with Google's search engine as the default for the popular 360 web browser.

iResearch thinks it will be tough for Qihoo to challenge considering the strong search technology and dominant market lead. The chart below shows the market coming to a different conclusion since the end of October.

BIDU Chart

BIDU data by YCharts


While the market has turned very pessimistic on Baidu, the company provided very strong guidance for Q4. As reported on the Q3 earnings report, the company expects the following numbers for Q4:

Outlook for Fourth Quarter 2012:

Baidu currently expects to generate total revenues in an amount ranging from RMB6.155 billion ($979.3 million) to RMB6.345 billion ($1.010 billion) for the fourth quarter of 2012, representing a 37.6% to 41.8% year-over-year increase. This forecast reflects Baidu's current and preliminary view, which is subject to change.

Stock Valuation

As mentioned above, the stock trades at an extreme discount, trading at only 14x analyst estimates for 2013. Analysts expect 26% earnings growth next year so clearly the valuation doesn't match the growth rate.

2-Year Chart- Baidu


The audit issue remains a big focus of the market and a primary reason pushing down Baidu and all Chinese stocks. Ironically, all stocks except the competitor that has been unsuccessful in taking market share from Baidu as shown above.

Baidu might provide one of the best valuations in the market. Investors need to realize that the revenue base is only one tenth that of the nearly $42B expected by Google (NASDAQ:GOOG). The company has a ton of growth remaining and no real signs exist that the company is losing out in mobile traffic or to new competitors.

Investors should keep the stock on a watch list until the stock bottoms out. At that point, it might be one of the cheapest growth stocks in the market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please consult your investment advisor before making any investment decisions.