Baidu, Inc. (BIDU) stock has been tumbling since last year. Since the announcement of its fourth quarter results, the stock has further dipped by around 20%. Even though the company's top-line saw a growth of 41% in the fourth quarter, it is almost half when compared to the previous year's top-line growth of 82%. This decelerating growth is mainly due to growing competition in the Chinese online search market from players like Qihoo, Sohu.com and Sogou. Another pressure on the company's earnings is from the contracting margins. Baidu reported its operating margin at 45% as compared to 51% in the previous year. This was because of a 70% huge jump in R&D expenses in the fourth quarter, which is expected to continue in the near-term. Let's discuss the stock in detail and find out how far this bear rally will continue?
The threat - rising competition
Once a dominant player in the market, Baidu's market share is shrinking- from 71.5% in the beginning of 2013 to around 70% in March, 2013. The Chinese online search market is witnessing heavy competition with the entry of many new players. Among the competition, one of the biggest threats to Baidu is Qihoo 360 Technology Co. Ltd. (QIHU). Since the start of its own web browser Qihoo 360 in August, 2012, the company has already gained 10% of the market share. This clearly shows Qihoo's power in capturing the upstream traffic in China, pressuring Baidu to alter its channel strategies. Qihoo, which has already proved its dominance in the free security software market, is now eyeing the browser market by targeting around a 40% market share by 2015 with 10% increment annually. I feel the competition will further get fierce in the market, affecting Baidu's profitability in the future.
Another threat - slowing growth
The Chinese search advertising market is experiencing slower growth, after solid upside in the past few years. According to iResearch, the growth rate was just 49% in 2012, as compared to 55% and 67% in 2010 and 2011 respectively. This growth rate is further expected to slowdown in the coming years due to market saturation and sluggish economic growth in the country. In the next three years, the market is expected to grow at a CAGR of 24%, aggravating the trouble for Baidu.
Additionally, Baidu's mobile strategy is lacking, with its low market share of 35% in the mobile search market. Being fully focused on search monetization, the company missed various opportunities to develop the mobile ads market. Mobile accounted for more than 30% of Baidu's search volume in the fourth quarter of 2012, but only contributed low single digits to its revenue. Currently, the Chinese internet market is in a transition phase with more users shifting to mobile as a platform. I feel the future performance of the company will depend upon mobile monetization to a great extent. In the near-term, it would be really difficult for the company to raise its market share, because of the fragmented nature of this market. Therefore, the main challenge for Baidu is to develop attractive products and services to retain mobile internet users and to further increase the revenue per user on this platform.
The Opportunity - Baidu Eye
More commonly known as the Google of China, Baidu tends to follow in Google's (GOOG) footsteps. This time it is in the smart glass space, where Google has already unveiled its efforts via Google Glass. Google Glass is a wearable technology along with the lenses to be used as a display monitor. The lenses are large enough to vocally interact with many services such as searching on Google, navigating via Google maps and much more. The complete version will be released in the fourth quarter of 2013 and will be targeted as a supplement for a smartphone. I am long Google, and here are the reasons, why.
On similar lines, Baidu recently announced that it is developing digital eye-wear to compete against Google Glass. The project is codenamed as Baidu Eye, which will capitalize upon Baidu's strengths in image search and facial recognition. The device will be equipped with a small LCD screen, which will help users to make image and voice searches. As of now, Baidu hasn't confirmed any date for the commercial launch of the device. However, I feel this can bring in additional revenue opportunity for the company which is struggling at its core offerings. The company can push its device into the market at an affordable price as compared to Google. Baidu is continuously expanding its business model to replicate Google's growth story. And, I feel this could be the right step in that direction.
The bottom line
At this moment, I am more concerned about Baidu's slowing PC search growth, which is challenged by new competition and macro pressures. Online ad spending is unlikely to rebound before late 2013. Moreover, the company's weakness in mobile internet search further dampens the sentiment. Baidu Eye is definitely a strong opportunity, but its impact would be visible only in the longer-term. In the near-term, the stock lacks any catalyst which would drive it upside. I am bearish on this stock in the short-term.