Shorting Baidu Easier than Shooting Fish in a Barrel

The last time Baidu (BIDU) reached these levels, I pleaded my case for the need to short "at will" in a May 2008 article, titled “A Train Headed for Derailment” and yes, the train did skid off the tracks on its way down to the low $100’s. Well, here we go again, because approximately 15 months later, BIDU is coincidently presenting nearly the identical scenario.

Going short now is like shooting fish in a barrel because it is so overvalued and overhyped. The stock has more than tripled since the beginning of the year and now trades at a staggering 58 times 2009 earnings estimates. It has simply gone up too far in too short of a time frame and is quite vulnerable to a nasty selloff of more than 20%, especially with earnings expectations ratcheted up to such sky-high levels.

Don’t get me wrong, BIDU is a great company, its price however has gotten way ahead of itself. The company is expected to earn $8.20 per share in 2010, up 42% from 2009 estimates of $5.78. That represents impressive growth, but are the analysts considering any Chinese search market share improvement by GOOG and YHOO? Credit Suisse estimates that competitors will erode away at BIDU’s market dominance in the next three years, clipping it a powerful 1300 basis points from 59% to 46%.

If you compare the price multiples of GOOG and BIDU you will detect a disconnect. BIDU is selling at 41 times 2010 estimates while GOOG is selling at only 17 times its estimates. BIDU’s cash position represents only 3% of its $11.7 billion market cap while GOOG’s $61 billion cash hoard equates to a much more respectable 14% of its $136 billion market cap. Don’t get me wrong, BIDU deserves a higher multiple because of its superior growth rate, but three times the valuation is sheer insanity.

Extreme high risk: Buying BIDU at these nose bleed levels is similar to playing high dollar slots in Las Vegas. It is high risk, but without the high reward, as most slot players always end up poorer than when they started. This Thursday, BIDU is reporting second quarter earnings and the “street” is expecting an awful lot. Sales are forecasted to come in near the $158 million mark, while earnings are slated to top the $1.43 mark. BIDU should have no trouble surpassing these expectations, as they are proficient at under promising in order to over deliver.

The problem is, even a blowout (such as sales of $170 million and earnings of $1.89) will not keep the share price from collapsing as most traders have already bought the rumor and will be selling the news. The main risk is the “street“ will not take kindly to tepid guidance - remember how bad GOOG got hit just last week on a more than “decent” report.

Analyst opinions: Although Credit Suisse downgraded its opinion from neutral to underperform on Monday, it strangely raised its one year target price on BIDU by $50 at the same time. This type of Broker action just exemplifies some of the silly antics of Wall Street.

Overall, the 16 analysts that provide research coverage on the company have a median $262 price target, indicating the stock has gotten ahead of itself as momentum traders and panicked shorts probably provided a good portion of the stock’s upward fuel. But when these sources burnout, look out below.

Bottom line: The stock is too expensive. Chasing it at these levels is similar to getting in on a pyramid scheme - you are okay if you are in the early stages, but if you are late to the party, watch out. You could be the one holding the bag when everybody tries to hit the exits at the same time. This is a $200 stock at the most. Short now and cover and go long in the low $200s, it’s easier than shooting fish in a barrel.

Disclosure: Short GOOG and BIDU

Comments

[Stone Fox C...:]

The only problem is that BIDU trades at a 40 multiple but expects 42% growth as you suggests. That is actually pretty cheap especially considering they are likely to beat estimates with the way China is now ramping up growth again.

Jul 21 12:16 PM

[Danny Furman:]

Leaders naturally deserve a premium and in China leaders are chosen, protected and fed by the government. China's economy is anything but short-able and, while I agree with the author's points they depend on markets in China being free/open, which they are not. Having said that, shorting BAIDU makes a lot more sense than going long at $250+.

Jul 21 12:17 PM

[doubleshortetf:]

Been to China over 30 times since 1998 while working for 3 multinationals. It's amusing to see "experts" who has not been to China or spent few days in the big Chinese cities recommending Chinese stocks... Wonder if they ever spent weeks at a time in gritty factory towns or poor interior areas...

Some sober facts:

1. China is a communist country ruled by 1 party with iron grip. Party bosses pick the politicians and many private company managements since many private companies are ex-SOE (communist state owned enterprises).
2. Corruption in China is rampant and one of the worst even down to lower ranking employees. Even factory canteen chef gets "envelopes" in scheme where he claims he received 10 bags of rice when only 8 bags are delivered.
3. There is almost no "law" since law itself is written to support the communist party or corrupt local communist bosses. Judges are appointed by the local communist boss and few if any understand law. Many judges got job thru "guanxi" or connection and of course bribes.
4. The Chinese banks in are BIG TROUBLE. E&Y got in heaps of trouble for discussing hidden bad and uncollectible debts. Local communist cadres dictate banks to lend to their pet projects and of course friends who bribe them not to mention COMPLETE lack of transparency.
5. No one except pea size brains trusts the communist government's statistics which are MANIPULATED.
6. Many of the listed companies numbers are COOKED. Auditors and their management can be bribed and extorted. It's beyond me how anyone would trust Chinese companies' financials unless audited by Big 4. And even Big 4s audited numbers are suspect since most Chinese companies carry multiple books including one for taxation and another for real book with slush funds.
7. Latest Chinese share and commodity appreciation have lot to do with communists pumping money to the economy by directing the banks to make loans. This kind of stimulus cannot go on.

Lemmings are lining up in China and now outside investors eager to participate in another bubble so let it be. Haven't we seen this all before with the tech and excess liquidity bubbles of 2000 and 2008 here in US?

Now is good time to buy FXP when all the investment gurus and amateurs in unison are recommending Chinese stocks.

Jul 21 12:23 PM

[WhoisJohnGalt:]

I like the numbers you put out there, but to get more people on your side, consider some qualitative factors to Baidu's rise and (eventual) fall:

1. China has indirectly demonstrated its willingness to promote Baidu's presence within the country by shutting out Google due to the pornography exposure issue. With government backing, Baidu's short term prospects look healthy.

2. However, we should extract the story of Google and apply to its Chinese counterpart. The markets were not pleased by Google's earnings because revenue growth was just a hair better than expected. Where/how will it continue to sustain itself? At this point its ad click business may be saturated to capacity. Baidu will face a similar issue as it swallows up search engine market share in China. From here, the issue will be how successful it can expand itself i.e. online OS.

Baidu from a speculator's sense certainly looks like it is getting ahead of itself, but its robust price may incorporate opportunities hidden from the uninformed investor.

Jul 21 12:38 PM

[H.J. Huneycutt:]

I totally agree on BIDU; though, I don't know if I'd be gutsy enough to short in real life. These irrational momentum stocks can be frightening. All the same, I think it almost has to go down at some point.

Jul 21 12:55 PM

[FiscalFallout:]

BIDU may well be undervalued, perhaps Google with its various issues might be a better target, but they too keep innovating and growing, maybe look elsewhere for a short.

Jul 21 03:04 PM

[bobbobwhite:]

I know about China, especially its grey market. A guy I know buys Tiffany knockoffs that retail at $130, targeted to the 16-25 female demographic. He has them made for $8 in China, right down to the Tiffany trademark, and sells them for under $30. Showed me one and compared it directly to the original and it looks 98% as good; few could tell the difference. He orders them by the gross and can't keep them in stock. Lots of "trade" shows, flea markets, pawnshops and the like sell tons of grey market stuff made in China. Check any jewelry your daughter owns made by Tiffany...good chance it is a Chinese knockoff unless she bought it direct from Tiffany. And even then...............who knows?

Yes, China is as bad as the Russian mafia. China cares nothing about law, patents, or legal rights. What an indictment of the communist rule there....and we are supposed to respect its growth, much of which is by illegal means? China will never get any of my investment money.

Jul 21 04:09 PM

[Shane Farley:]

Again, its all about bid prices. not communism, Google, Chinese govt, etc. Baidu has reached the critical mass of having 200k advertisers who are all hyper learning how to bid for millions of search terms. Bidding war has begun. Lots of land grabbing on the web is going on in China because of its hyper growth. Do the math, what happens when the average click goes from $.8 - $.12 to $40. Baidu profit explosion. Get ready. Niche players crowd bigger players and bid up niche terms extensively. Like Google in the USA, baidu advertisers are trying to get as many clicks as they can. Bidding system advancements, keywords selection for advertising, etc is all getting much better.

Jul 21 04:49 PM

[nmelendez:]

That's why you should buy into China and deflation. :) Make some money from the same fools who bought subprime CDO's.


On Jul 21 04:09 PM bobbobwhite wrote:

> I know about China, especially its grey market. A guy I know buys
> Tiffany knockoffs that retail at $130, targeted to the 16-25 female
> demographic. He has them made for $8 in China, right down to the
> Tiffany trademark, and sells them for under $30. Showed me one and
> compared it directly to the original and it looks 98% as good; few
> could tell the difference. He orders them by the gross and can't
> keep them in stock. Lots of "trade" shows, flea markets, pawnshops
> and the like sell tons of grey market stuff made in China. Check
> any jewelry your daughter owns made by Tiffany...good chance it is
> a Chinese knockoff unless she bought it direct from Tiffany. And
> even then...............who knows?
>
> Yes, China is as bad as the Russian mafia. China cares nothing about
> law, patents, or legal rights. What an indictment of the communist
> rule there....and we are supposed to respect its growth, much of
> which is by illegal means? China will never get any of my investment
> money.

Jul 21 04:49 PM

[Ricard:]

Your argument has merit. Personally, I do not understand GOOG's business model, much less the foreign version. I've been considering some sort of position in either of them, but especially for GOOG, I simply cannot connect the dots between what it does outside of search and $$$. I find this disconnect disconcerting, but not enough to short it.

For BIDU to already approach its all time high has to be a warning sign...yet it's in China. I've yet to find anything in China that I have the fortitude to short, and I'd be surprised if BIDU was *the one*.

Jul 21 10:16 PM

[Arthur Hau:]

Baidu is NO Google!

1. Google is an innovator; Baidu is a follower.
2. Google is an international company; Baidu is very localized occupying a market that does not respect intellectual property rights.
3. Google has a diversified portfolio of technologies; Baidu?
4. Eventually, Google has to fight MS; Baidu is nothing close.
5. Google has a very strong vision, i.e., to use the internet as the ultimate computing base; Baidu has no vision of any kind.

Jul 22 09:55 AM

[TvonT:]

Thanks for your thoughts. I'm nicely ahead on this trade this morning ( I was nervous yesterday); stock is off 2% percent in the 1st hour of trading and still headed south.

I've got the mantra firmly attached to my monitor: Pigs get fat and Hogs get slaughtered. This is not a long term trade, get the $ and get out.

Yeah!

Jul 22 10:13 AM

[Mark Krieger:]

I appreciate your kind words..I covered...i too don't want to get greedy...


On Jul 22 10:13 AM TvonT wrote:

> Thanks for your thoughts. I'm nicely ahead on this trade this morning
> ( I was nervous yesterday); stock is off 2% percent in the 1st hour
> of trading and still headed south.
>
> I've got the mantra firmly attached to my monitor: Pigs get fat and
> Hogs get slaughtered. This is not a long term trade, get the $ and
> get out.
>
> Yeah!

Jul 22 10:46 AM

[tory:]

The story hits the nail on the head BIDU is an excellent short same for google. As a technical investor I would not hesitate to short this stock as it's on it's way down. This stock could literally head down to $275 pull some shares off, If it comes down to 265 continue to short the stock. It may go all the way down to $196.

Jul 22 12:25 PM

[Ricard:]

1) Google innovates, but tell me where the $$$ is in Google Earth, Google Apps, Google Chrome (a very flawed product that I stopped using a couple weeks ago) or Google anything-else-outside-...
2) Baidu is in the largest internet market in the world. It captures the 'local flavor', something that given all of the inhibitions of foreign investors, will count as a large plus.
3) Again, please equate those 'technologies' outside of search to $$$.
4) Huawei will eventually have to fight Cisco, if it isn't already. Had Huawei issued ADRs 5-10 years ago, I would have bet the farm on that one. Besides that, I don't see a fight with MSFT as a positive.
5) Baidu has one vision: $$$$. It's the only one that matters. I'm not sure Google has that vision outside of search.

I will add:
6) Google, like AAPL, is riding a wave of popularity. Its earnings are slowing, and people are questioning the text-only ad revenue strategy. Google's main markets are all mature, whereas BIDU is in what will probably be the biggest growth story of this century.

All this being said, I think there are better companies than BIDU to invest in, but Google IMHO is not one of them.


On Jul 22 09:55 AM Arthur Hau wrote:

> Baidu is NO Google!
>
> 1. Google is an innovator; Baidu is a follower.
> 2. Google is an international company; Baidu is very localized occupying
> a market that does not respect intellectual property rights.
> 3. Google has a diversified portfolio of technologies; Baidu?
> 4. Eventually, Google has to fight MS; Baidu is nothing close.<br/>5.
> Google has a very strong vision, i.e., to use the internet as the
> ultimate computing base; Baidu has no vision of any kind.

Jul 23 12:58 PM

[Mark Krieger:]

after today's $28 rise, I think it is time to short again as the market will end up giving back some of the gains by the bell

Jul 24 12:06 PM

[Happy4LA:]

Really Mark, time to short again? What makes you think you know what you're talking about? The stock was up $25+ today, and your headline says "Easier than Shooting Fish in a Barrel,"? Talk about irresponsible... a little hyperbole don't you think? What a huge mistake and you are now advocating compounding that mistake.

Jul 24 06:04 PM

[Ricard:]

Hm...some numbers:

GOOG market cap: $141.1 bn

BIDU market cap: $12.4 bn

The kool aide's all on GOOG's table, IMHO. I've already explained my reasoning in a prior post. Still, the P/E is rather high for BIDU, so I'm staying away from both of these.


On Jul 21 09:03 AM Mark Krieger wrote:

> Shane: I kind of see your point, but don't you think you could be
> drinking the kool aid on this one? Most of the growth and then some
> has already been factored in the current share price. At this point
> the hype on this stock reminds me of "irrational exhuberance" and
> tulip crash. The risk on this sucker is sky high at these elevated
> readings.The law of bigger numbers always comes to play in growth
> stories and your assumptions do not seem to take into consideration
> competitors gaining market share.

Jul 24 10:00 PM

[Beyond Trading:]

(BIDU) was a great play on the long side before earnings for two major reasons:
1) stock has been supported by Goldman Sachs (GS) bullish view ahead of earnings
2) Most retail investors and traders were shorting the stock

If you want prove when you should had covered the stock to go long read our real time alerts in (BIDU) on StockTalk warning investors to close short positions at 277 and 269.5 several weeks ago. We recommended to sell long positions on (BIDU) at $257. Article to follow

Jul 26 04:41 PM

[Happy4LA:]

Mark, are you bankrupt yet?

Jul 27 01:59 PM