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Tech stocks have been the talk of the month since most technology companies such as Google (NASDAQ:GOOG), Facebook (NASDAQ:FB) and LinkedIn (NYSE:LNKD) announced their quarterly results. While investors cheered for most of the results, some were a bit disappointing. Google was the pick of the stocks, with its share price crossing the $1000 mark for the first time. Baidu (NASDAQ:BIDU) was also among the tech companies that showed strong growth in its third quarter despite concerns about increasing competition in the Chinese search market. The company has raised its guidance for the fourth quarter, as mobile revenue continues to grow at a rapid pace.

Secure your return with Baifa

Baidu is diversifying its business to financial services, launching an online wealth management platform, Baifa, on Oct 28. The new investment platform is in collaboration with China Asset Management, and will aim to produce 8% annual yield for depositors. After, Alibaba and Tencent Holdings (OTCPK:TCEHY), Baidu is the latest Chinese search engine giant to foray into financial services. These technology giants have sought permission to build financial service platforms to offer mutual funds, loans, and other financial products to web users. We believe that this is a good opportunity for Baidu to venture into financial products with such a yield, especially looking at the low interest scenario at most Chinese banks. In July, Alibaba launched a mutual fund platform Yuebao that offered interest rates of over six percent. It gained 2.5 million registered users who deposited $1.07 billion within 18 days of its launch. Yuebao has achieved 16 million users with more than $21.3 billion in investments so far. Analysts have estimated that Baifa will attract investments of more than $16.42 billion by the end of this year.

Users can participate with a minimum investment of $0.16 in Baifa. Baidu will help build users' portfolios and will try to deliver more returns on their investments. In comparison to Yuebao, Baifa's registration process may hinder users joining its platform. In Yuebao, users can transfer an amount from their Alipay account, Alibaba's payment solution, through smartphones, but Baifa users have to create an account on Baidu Wallet to participate on Baifa. Baidu Wallet doesn't have a lot of users compared to Yuebao, and it will have to attract a lot of registrations through its promotion. Baifa sold financial products worth more than $164 million and registered more than 120,000 clients in just five hours of its launch. The early success depicts the growing demand of wealth management products in China and the potential for Baidu to attract investments from users.

Why are expenses rising?

In the third quarter of 2013, Baidu's revenue surged 42% year over year, with net income growing by just 1.3%. Rising expenses took a toll on company's profits, as Baidu has increased its investment in mobile initiatives. Baidu is seeing a trend towards greater mobile usage and a decline in its PC share; therefore, it has stepped up its marketing efforts for mobile to strengthen its position.

(in thousand dollars)
Q3 2013Q2 20132012
Revenue145300012320003570672
(as % of revenue)
SG&A Expenses15.64%14.36%11.24%
TAC11.68%11.64%8.68%
Income34.27%34.97%47.00%

Baidu has seen a gradual rise in both selling, general, & administrative expenses, or SG&A, and traffic acquisition cost, or TAC. SG&A expenses as a percentage of revenue have increased to 15.64% in third quarter from 11.24% in 2012. Aggressive efforts on mobile products were responsible for this rise, and mobile related expenses are expected to continue in the coming quarters. Mobile business margins are less than its core PC search business due to lower ad prices on mobile. However, due to mobile business's minor contribution, Baidu's overall business won't be affected in the coming quarters. Although TAC as a percent of revenue remained flat at 11.68% in the third quarter from previous quarter, it has grown by three percentage points from 2012. Ad and halo123, a web directory, promotions were the driving factor for this increase.

The rise in marketing efforts will reflect gradually, as mobile search revenue continues to grow with the help of 91 Wireless app store and the new Light app platform. Baidu is number one in mobile search and has a total installed user base of 330 million in the third quarter of 2013, a whopping 50% rise quarter over quarter. We believe that increasing mobile traffic should drive Baidu's search customers to allocate more of their ads budgets to mobile in comparison to PC. Overall, Baidu is well positioned to capitalize on the mobile segment.

The decline in PC traffic and rising competition in the search business has prompted Baidu to turn its focus towards mobile. In our last report, we discussed the Tencent acquisition of 36.5% stake in Sohu (SOHU)'s search engine Sogou, and how Qihoo (QIHU) found it difficult to expand its search-engine market share with this acquisition. Tencent wants to increase its Chinese search market share and challenge Qihoo's growing share.

According to CNZZ, Qihoo has gained market share and reached 23% share in October 2013 from 19% the previous month in terms of unique visitors. Baidu, Sohu, and Tencent have all lost their search share to Qihoo. It has achieved significant growth since the launch of its search services in August 2012, and the company has already surpassed its targeted 20% search traffic market share. Qihoo is going to announce its third quarter results on November 15 and expects revenue to be in the range of $181million -$183 million compared to $151.7 million in the second quarter. Due to the growing traffic on its search engine, we expect a growth in search revenue in the coming years.

In the recent third quarter results, Sogou generated revenue of $57 million, a 53% year-over-year increase. Sohu has been devoting considerable effort to integrating Sogou and Tencent's search, thus bringing more traffic and synergies to both companies. While competition from Qihoo and Sogou will likely lower Baidu's market share, we believe the impact won't be significant in terms of revenue share.

Bottom line

Baidu is on the same path as Tencent and Alibaba, diversifying its business from online services to financial. The company has seen strong signs in the mobile segment in its third quarter results. According to Yahoo! Finance, Baidu's EPS is expected to be $40.40 in 2014, with an earnings growth rate of 30.6%. In terms of PEG ratio, Baidu's ratio of 1.46 is on par with Google and much cheaper than Facebook. We believe the key to Baidu's growth is mobile, which will keep its leadership position in the search market intact, and revenue contribution from its new financial service business should present an upside potential for shares.

Source: Baidu: Not Just A Tech Stock Anymore