We had earlier written that Baidu (BIDU) might not be a good investment as the company's revenue growth has started to slow down due to its increasing competition and lack of growth in non-search areas. Baidu released its 4Q12 results in which the revenue slowdown fears seem to be coming true. The company's expenses also showed a sharper increase with TAC, SG&A and bandwidth all increasing at a faster rate than revenues. The company failed to disclose the share of mobile revenues in the total search revenues. However, the management accepted that the mobile CPC is lower than that of desktop CPC. The ARPU has also gone down as the company targets smaller businesses. The company is also being forced to spend more as it faces competition from browser upstart Qihoo (QIHU) and other Chinese rivals.
Negatives from 4Q12 Results
Revenue Growth Trajectory showing a steep decline
The trajectory of Baidu search engine revenue growth has almost halved from that of a year ago. The company reported ~82% y/y revenue in 4Q11 which has come down to ~ 42% y/y growths in 4Q12. Though 42% growth is nothing to scoff at, the decline in the growth trajectory is of serious concern for a growth stock.
Expenses increased faster than revenues
Baidu reported an increase in expenses in almost every category. Content costs increased to 1.9% of the revenues from 0.6%. SG&A also increased by ~52% y/y which is almost 10 percentage points higher than the revenue growth. Bandwidth costs also increased to 5.3% of the revenues from 4.3% a year earlier. TAC also showed a serious increase to 9.6% of the revenues from 7.9% in the year ago period.
Guidance not great
Baidu has given a Q113 guidance of revenue being up 38-43% y/y; however this implies a sequential quarterly decline in revenues. The guidance also implies that the revenue growth slowdown is going to continue in 2013 as well. The earnings growth has slowed considerably due to margin contraction and topline growth slowdown.
Qihoo 360 Competition
Baidu had gained a lot of market share after Google (GOOG) decided to exit China. However, those days are over as Chinese rivals start to increase their investment in the lucrative search market. QIHU has become Baidu's strongest challenger of late, using its dominant mobile browser market share to increase the penetration of its search product.
Mobile CPC and Market share concerns
As consumers around the world increasingly use tablets and smartphones for Internet usage, PC search has started to decline. Mobile CPC is not as high as PC CPC which means that Baidu faces a major headwind from this PC to smartphone/ tablet transition. While some companies are navigating this transition better, other companies are having difficulty in doing so. Baidu's market share in the mobile search segment is also much lower than the PC search segment
Cloud Computing and Mobile Investment Risks
Baidu has been very late to the cloud computing and mobile internet space. The company has now decided to spend massively on these two areas. The company recently issued 10 billion yuan in bonds to build a cloud computing centre. The company is also increasing its R&D focus on these two areas, such that 25% of its total R&D expense goes into bolstering its products in cloud computing and mobile internet.
Positives from 4Q12 Results
New Products such as Quran, Map and Mobile Browser gaining traction - Baidu is seeing good growth in its newer internet product and services such as the MAP app which grew by 50% q/q and now has 3.5 million active daily users. The company's online travel and video products also got good traction during the quarter.
Valuation is not expensive now - Baidu used to trade at nosebleed P/E levels in the past, as the company regularly beat analyst estimates during its quarterly results. However, the valuation has come down to more earthly levels with a trailing P/E of ~ 24x. However, in the technology industry the "E" can quickly decrease, which makes it's a false source of comfort. The company is not very expensive now given that its valuation has come down quite drastically compared to 5 years ago. However, it is still not a bargain given the increased risks it faces from newer technology trends and slowing revenue growth.
Stock Price Performance - Baidu's stock is currently down 10% after the results to ~$95 falling from ~$105 before the announcement of the results. The company's last two quarter results have not been great and the concerns about mobile transition and slowing revenue growth are increasing. The stock has traded in a range of ~$85 to $154 in the last year. The stock is now only around ~12% above its recent low.
Baidu is the biggest Internet company in the biggest global market (in terms of Internet users) and generates a massive amount of FCF. However, the company is not an innovator and almost always copies other companies products and services. Except for PC search, Baidu has failed to be very successful in other areas. While the company is investing heavily in other technology areas, it remains to be seen whether it can compete effectively in those segments. The stock has taken a 10% beating post the 4Q12 results as the results show a sharp contraction in revenue growth coupled with faster than expected increase in overall expenses. We would be wary of buying Baidu here and would remain on the sidelines.