Based strictly on fundamentals and valuation alone, Baidu (BIDU) looks very cheap, and technically it looks like a decent low risk entry to go long. While I would recommend this at least as a short-term trade from the long side, in looking at the longer-term chart of BIDU and taking into account a potential slowing in the Chinese economy, as highlighted in part in the recent 60 minutes piece on a property bubble in China, perhaps this is an unwise choice. Let's look at the stats.
Below is a snapshot of the company's revenue and earnings growth over the past 5 years:
And here is the company's performance over the past 5 quarters to get a sense of recent trends.
Gross margins seem to have bottomed in Q1 2012 around 70% and have climbed back up to 73% in Q3 2012. Revenue growth is still above 40% and quarter-on-quarter in Q3, it was 14.6%.
What Does the Market See?
As you can see, the company's growth, while slowing down, is still very impressive. And margins are holding up well. So what is it that the market sees? I've always believed that the market knows best. It typically sees things well in advance of them showing up in any income statement or balance sheet. Many BIDU bears have pointed to QIHU as the sole source for BIDU's potential woes. They claim that QIHU is taking market share from BIDU and that eventually BIDU will have to pay through its nose to maintain its market share, eroding margins and results in falling profits. Is Qihoo (QIHU) really the BIDU killer?
Last week, I looked more into the QIHU story to see just how much of a risk it is to BIDU. What I found was a management team with little credibility that gave me no trust in their claims about stealing market share from BIDU.
First and foremost, the company's claims about its share of the search market, since this is what the market is so concerned about BIDU and enamored of QIHU. QIHU, as most people are aware, switched its business model from directing traffic to Google China and other search engines through its Qihoo browser to generating search traffic directly from its own in-house search engine, launched in August 2012. Immediately thereafter, Qihoo was claiming that it had 10% market share and that it was taking that market share from BIDU. At first blush, it appears to be quite a feat, and it might lure investors into believing that it is poised to dethrone BIDU. Investors may be left in awe, wondering how it was that it could grab such a large percentage of the market immediately when other companies, like Sohu (SOHU) and NetEase (NTES), have been around for years and have much smaller market shares.
While it may be true that Qihoo's new search engine has this market share, I think it is incredibly deceiving to imply to investors that it simply gobbled up this market share from BIDU without acknowledging its share of indirect search that it had previously. Through its own browser before the launch of its search engine, QIHU was generating approximately 15% of the entire search market. That is, it was directing search traffic to China Google, BIDU, and a variety of other search engines directly from its own browser and that search traffic made up about 15% of the overall market.
So Where Does that Leave BIDU?
The question is, if the QIHU fears are unfounded, then is BIDU a buy?
A Good Entry Point at the Least
I believe this is a very interesting entry point at $86 from the long side as the stop out point would be below a potential double bottom around $84. I think the overall weakness in this stock over the past 3 months and really over the past 2 years while the overall market has run higher is a cause for concern to many, but not me. I still see a company whose topline and bottom line are growing rapidly. The company sports net margins of almost 50%, which is unheard of. Google (GOOG), by comparison, has net margins of 20%.
Speaking of Google, do you remember the fears people had about this just last summer? Too much spending and not enough monetization of mobile. Sound familiar? Many doubters talked about how Google was spending massive amounts of money to maintain growth and that it was losing market share in mobile search and that it had little in the way of monetizing its mobile platform. Well, fast forward 9 months and the stock is up 45% and at all-time highs.
Baidu, the King of Advertising in China
According to WantChinaTimes.com, BIDU is about to become the "king of advertisements" in China as the analytic nature of its ads has won the trust of its advertisers.
"CCTV has dominated the advertisement field for at least 22 years, but the growth of Baidu's ads has outpaced that of CCTV. Last year, Baidu's ads income reached 22.2 billion yuan (US$3.6 billion), up 53.5% from a year earlier, while CCTV had an ad income of 26.9 billion yuan (US$4.3 billion), up less than 15% from a year ago. If Baidu keeps on target with these growth figures, it is set to pass the broadcaster this year, the report said."
So with all of this in mind, does it really make sense to be paying only 16 times earnings for BIDU? I don't think so. I think BIDU is a buy, dude.