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Baidu (NASDAQ:BIDU) is the biggest player in the Chinese online search engine market. It has seen its revenue increase at a CAGR of 84% and net income at 115% over the last seven years. This resulted in its stock rise from its IPO price of $27 in 2005 to $157 in 2011. That's a return of around 500% to investors. But since April last year, the stock has experienced a steep decline of more than 43%. It is currently trading at around $83.

This fall in its price was due to slowdown in its growth. But isn't that natural for a maturing company? The company might not grow at 84%, but its revenue still increased 54% and its net income increased 57% in 2012. This is phenomenal for any company in any industry. Before commenting on the future stock price movement, let's just have a look at some important factors first.

Chinese online search advertising market

The Chinese online search advertising market grew by 49% in 2012 to reach 25.6 billion Yuan ($4.1 billion). This is a phenomenal growth rate for any industry. But it was relatively slower as compared to the growth rates of the last few years. The market is now expected to grow with a CAGR of 24.6% during 2013-16 to reach 67.2 billion yuan ($10.7 billion). Baidu currently has around 80% market share. This is expected to come down a little, but the revenue growth for the company would still be phenomenal in the next few years. As search advertising contributes around 60% of the total revenue of the company, this expected growth in market size might result in share price appreciation in future.

Chinese economy growth

The Chinese economy grew at 7.7% last year, compared to an expectation of 8%. This has been made a big issue by global investors. Some analysts believe a 'slowing' Chinese economy will slow down Baidu's growth as well. While it is true that China grew slower than expected, but the growth is still one of the fastest in the world. Further because of the Chinese government's stimulus plan for the next five years, the economy is expected to come back on track soon. Therefore it would not be reasonable to expect any slowdown in Baidu due to this reason in long term.

Limitations in mobile market

The Chinese mobile internet market has grown with a CAGR of more than 53% over the last four years. In 2012, around 75% of the total internet users in China used mobile to access the internet. Baidu's market share is just 35% in mobile search engine market. This is because there are a number of local players like Tencent (OTCPK:TCEHY) and Easou, having substantial market share. Also because mobile platforms are tougher to monetize due to the small screens, Baidu will find it tough to capture more market share in this fragmented market.

Competitive Market

Qihoo (NYSE:QIHU) launched its search engine in April 2012. It has already gained 10% market share and expects to reach 20% by the end of this year. This has been a very competitive rivalry so far. Recently Baidu has launched antivirus PC software in collaboration with security expert Kaspersky, directly in competition with Qihoo.

Qihoo's stock has been on an upward trend since the search engine launch and has given its investors a return of more than 100%. The trailing P/E ratio of the company is 126.88, much higher than the industry average of 14.29. Its P/S ratio is also very high. This suggest huge over valuation of the stock right now. But the forward P/E ratio is 19.82, suggesting a high EPS growth forecast. With no debt, the company has enough room to expand. Therefore if the company continues to capture more market share, its stock might become a profitable investment.

Google (NASDAQ:GOOG) is the fourth largest player in the Chinese search engine market. It currently holds just around 4% market share, much lesser than around a year back. Its other services like Google Maps have also lost a considerable amount of market share recently. Google's revenue from China is negligible as a percentage of the total revenue, but it can't afford to ignore such a huge and growing market. Its less than 5% market share still amounts to more than 25 million searches. It has recently agreed to implement Chinese censorship rules in search results. This reflects Google's continued efforts to make its presence felt in China.

Conclusion

Baidu's revenue growth rate was 80% during 2011. But it has now significantly come down to around 41% in Q4 2012. No company can sustain 80% growth rate forever and this slowdown is an indication of the Chinese online search engine market maturing. But still Baidu is the market leader by a long margin. With the market expected to grow at a rapid rate for the next few years, the growth forecast of the company is optimistic.

But there are certain limitations to the growth of the company. The online search market is becoming highly competitive. Chinese economy slowdown might affect the company in short term. Also the company might not be able to tap the full potential of the mobile search segment. Therefore, even though its trailing and forward P/E ratios are trading at a discount to the industry average, the stock might not give any substantial returns in near future.

The company has strong balance sheet. It has high operating cash flow, high return on equity, high current liquidity and high profit margin. This will ensure that the company keeps growing at a rapid rate. The company has a very high EPS growth forecast for the next five years, and therefore has immense upside potential for a period of three to five years.

Source: The Chinese Google Is A Better Buy Than The Original One