Top Chinese internet search giant Baidu (BIDU) has seen its shares grow 50% in value year to date behind strong sales and growth initiatives. We believe company stock has potential to grow an additional 20% in the next 12 months as we have a Hold recommendation with a $184 price target. Baidu has promising expansion projects in store, but key valuations are slightly higher than we would like at this time, holding us back from rating it a as a clear Buy opportunity.
It is no surprise that Baidu is the clear dominant player of the Chinese search engine market with a 63% market share. This number, however, has been decreasing over the last year, as market share in 2012 stood at 78% for Baidu. Competitors are gaining ground, as China's third and fourth largest search engine providers Sogou and Soso have recently merged to form a 14% overall market share.
As the battle heats up, Baidu looks to stay one step ahead of the competition by focusing on improving the mobile search experience for customers. The mobile segment is a strong catalyst for future growth, as mobile search traffic is becoming more popular. Mobile search traffic grew at a 94% rate in 2012, compared to a 20% decline in PC search traffic for the same period. Smartphone subscriptions are expected to grow at a higher rate than total mobile subscriptions, fueled by the introduction of LTE service by the end of the year. At a 100% growth rate from 2012 to 2013 and another 50% expected growth rate through 2014 for smartphone subscriptions, mobile internet offers Baidu ample room for growth.
Going hand in hand with mobile smartphones is the expansion of software applications. As of October 1st 2013, Baidu finalized its acquisition of 91 Wireless, a developer and operator of app distribution platforms. Mobile gaming accounts for the majority of app downloads in China. Among other services, 91 Wireless functions as a mobile game operator, which will help Baidu gain footing in this key market. The acquisition makes Baidu the largest channel for app distribution in China. Another key mobile development is the introduction of Light App, an app dedicated to offering users exposure to less popular apps. Currently, 0.1% of apps account for 70% of total download. Light Apps gives the other 99.9% of apps a chance for greater exposure and increases Baidu's traffic as a result.
SiteApp is another application that looks to improve mobile revenue by making it easier for companies to create their own mobile websites for free. This enables Baidu to capture mobile traffic and enables its customers to improve their online presence at minimal costs. The mobile advertising market will account for $2 billion by the end of 2013 and Baidu is strategically positioned to take advantage of it.
The commitment to innovation and expansion is evident in the company's research and development spending, which increased by 77% year over year as of latest quarter. SG&A expenses rose significantly as well, with a 115% year over year jump in the same period. These expenses have resulted in dismal operating profit growth of 1.2% year over year. However, we believe these expenses will payoff moving forward.
Compared to its main competitors, BIDU remains the better long term investment. At a pe value of 30.71, BIDU offers better value than its rivals Sohu.com (SOHU) and Qihoo 360 (QIHU), with astronomical pe values of 871.3 and 158.6. Adjusted to growth, Baidu's 1.34 peg value is more attractive than both SOHU and QIHU with double digit peg ratios.
Days Sales Outstanding is a key metric to determine the demand for a company's products. It takes BIDU 20.17 days to collect on its account receivables, less than both its competitors. However, this number has been increasing every year for the last 5 years, rising from 9.13 days in 2007 to the current ttm number of 20.17. This could signal that demand for Baidu's service is not as strong as before and the company has to broaden credit terms to its customers in order to maintain strong revenue growth. Gross profit margin of 62.8% has also been decreasing since 2011 and is currently lower than both its competitors SOHU and QIHU with 66.8% and 88.8% gross margins, respectively.
Baidu already has a large established customer base for its platform. We believe company projects and expansion into mobile will offer Baidu room for growth and make customers reluctant to switch to its competitors. At current valuations, Baidu offers a better value than its competitors, but sales and margin ratios suggest competition is becoming stiffer and growth rate may be peaking.
From 2013 to 2017 we expect operating income to more than double as the Chinese internet market continues to expand. At current valuations, Baidu has some of that growth factored into its share price. Nevertheless, we believe Baidu still has potential to grow an additional 20% in the next 12 months.
Additional disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.