Baidu Inc. (BIDU) is a Chinese company involved in providing web search services. The company was established in 2000 and is headquartered in Beijing, China. In addition to their core web search products, the company also provides community based products like Baidu PostBar (Chinese-language community platform), Baidu Knows (Chinese knowledge sharing platform) and Baidu Encyclopedia. Apart from these spotlight products and services, Baidu offers search based products such as maps, image search, video search and news search. Baidu also offers PC client software and mobile related software and services such as media players, readers, palmtop accessories, NetDisk and One-Click-Root etc. The company also acts as a media platform for online marketing customers. It offers performance based online marketing services and display adverts through its organic and affiliated websites. The majority of the company's revenue is derived from provision of online marketing services. To be more specific, around 99% of Baidu's revenue was generated through online marketing services in the year ended 2012.
Shares of Baidu are listed on NYSE. The year to date market performance of the company was healthy as it has posted a 56% growth in valuations. The second half of 2013 observed more growth than the first half. The main factor towards a 69% valuation growth in the 2H of 2013 is the consistent, above analyst estimate, revenue guidance. The disclosure to buy a mobile app store also contributed towards share price growth.
Revenue in billions
Baidu is expected to show 100% growth in EPS between 2011 and 2014. The revenues and EPS trends of the company have also spurred the market performance.
As the internet industry is set to grow in China, the companies operating in this and related industries will be provided with an opportunity to grow as well. Baidu is the leading internet search service provider of China with around 64% of the market share. Therefore, the company is well positioned to materialize on the growth factor of the Chinese web market and the search industry.
The factors that could derive the future growth of the company are discussed below:
1. Industry Growth:
Mobile Internet Users
Source: (CNNIC) China internet network information center
China's internet market still has promising future growth prospects. The country has the world's largest internet user population with 564 million users at the end of 2012, yet the internet penetration level is far below the level of penetration in most developed countries. China's internet penetration stands at 42.1% as compared to 81% in the US. Chinese internet users are expected to grow to 800 million by 2015, an increase of almost 42%. Furthermore, smartphones and tablets have been among the fastest growing trends recently. This will further accelerate the internet user growth in China because almost 70% of the first time internet users in China use a mobile device to surf the web. So, according to these facts and estimates it is safe to assume a healthy future growth rate for the internet market of China. Therefore, while global internet search industry is entering maturity, Chinese industry is still in the growth phase.
2. Acquisitive Strategy
Baidu is following a path of acquisitive growth that supplements its organic growth. The company signed an agreement to buy 91 Wireless Websoft Limited, a mobile app store, from NetDragon Websoft Inc. at a price of $1.9 billion. By acquiring 91 Wireless, Baidu will become China's largest mobile app and game distributer. The App stores of 91 Wireless (HiMarket and 91 Assistant) features around 900,000 Android apps and 93,000 developers (2012). iResearch ranked these App stores, collectively, as the No. 1 third party App store. 91 Wireless also has an open development platform with an integrated payment system. This gives Baidu access to an app ecosystem. The acquisition puts Baidu in a great position to capitalize on the growth factor of the app market. 91 Wireless has seen a surge of around 219% in revenues in the first quarter of 2013. This also indicates that 91 Wireless is a business with immense potential, which will improve Baidu's overall growth rate.
Baidu has also acquired a controlling interest in Nuomi Holdings for around $160 million by purchasing a 59% stake from Renren Inc. Nuomi is an e-commerce website operator and this acquisition shows the intention of Baidu to test new waters. The e-commerce website, Nuomi.com, will also complement the advertising business of Baidu. Nuomi has around 3.8 million active paying users. Nuomi.com also allows Baidu to leverage its location based services. According to CNNIC, a number of web verticals saw impressive growth, including e-commerce, which saw an 11.9% increase in user year-on-year. One other point to be noted here is that only 24% of the people in China shop online, which makes the e-commerce market open for future growth as a vast majority of the population are potential future online buyers. These facts are indicative of the opportunities provided by the acquisition of Nuomi.
The acquisitions carried out by Baidu also indicate that Baidu is in a transition, i.e. it is shifting from PC based to mobile based services and it is a valid move fueled by the growth of smartphones and tablets.
3. Competitive Scenario
The growing Chinese internet market is attracting new entrants and bringing stiff competition, which is the textbook consequence of any growing market. Although Baidu currently holds the largest market share in the search engine services, it recently lost some of its share to Qihoo, an internet platform company. Qihoo's market share for web search was around 9% in late 2012 and almost doubled in less than a year to reach around 18% recently. Qihoo is an emerging competitor of Baidu with a growth rate surpassing Baidu's. However Qihoo is facing certain lawsuits including a $104,000 lawsuit filed by Baidu. Qihoo has lost several cases recently including one lost to Baidu. Qihoo app logo is similar to Chrome and its official browser website is chrome.360.cn. All these facts points towards negative marketing by Qihoo. This strategy could prove to be expensive for Qihoo because of high payment for damages claims.
Qihoo recently entered into strategic alliances with reputed companies including Renren and Alibaba Holdings Inc. The Renren alliance will enable Qihoo to consolidate its user accounts with Renren and add web page interface. This development could affect the web app business of Baidu.
The deal of Qihoo with Alibaba involves an online shopping search engine. This will compete with Baidu in the e-commerce sector as 360.etao.com directs more traffic towards Alibaba.
Sohu and Tencent have also announced their strategic partnership. Tencent and Sogou (a subsidiary of Sohu) have agreed to jointly develop, cross-promote and integrate their respective products and services, while collaborating in areas of search technology, user insights and data sharing. Sogou's leading products, including Sogou Pinyin and Sogou Search, will have direct access to the vast user base of Tencent's online and mobile social communities. This partnership will give Sogou around 14% web search market share.
All these developments will affect Baidu's market share in the future. However, Baidu is also making acquisitions to counter the competition. Acquiring Nuomi is an example of a counterstrategy against the Qihoo and Alibaba deal. It is too early to say who might emerge as a winner when the market matures; but it is safe to assume that Baidu will survive the competition in the near future.
4. Fundamentals Overview
Baidu has shown a revenue growth in the past two years thanks to the growing internet market in China and several bans on Google Inc. imposed by the Chinese Government. The revenues posted a CAGR of 56% in the past three years (2010-2013). This is an impressive growth rate. Qihoo posted 112% CAGR in the same period but is well behind in absolute revenue terms.
Baidu has a very healthy profit margin, which is 36.6% (TTM) posting around 46.5% CAGR (2010-2013). Google on the other hand posted a profit margin of 21.7%. Qihoo observed a spectacular growth of 157% in the same period but still lies behind Baidu in absolute terms. Baidu's net income is around 18 times that of Qihoo's. This indicates Baidu is way ahead of Qihoo and even at the current growth rate it is not probable that Qihoo will surpass Baidu in the near future.
Liquidity and Cash Flow
The Company has a cash and cash equivalent balance of around $6.9 billion. Growing revenue generation and healthy profit margins led to such levels of cash. The current ratio of the company stands at around 4.12, which is above the industry average of 2.69. This confirms that the company has no short-term liquidity problems. In comparison, Qihoo has a cash balance of $1 billion and a current ratio of around 3. The balance sheet of Qihoo is also impressive but it still does not compete with Baidu's position. It is the inherent limitation of the size of Qihoo, as compared to Baidu, which limits its balance sheet outlook.
EPS: In line with revenues and net income, the EPS of the company also grew at a CAGR of 46.7% (2010-2013 TTM). EPS is calculated by using current outstanding shares to enhance comparability. Investors normally rely on the EPS indicator. So, the positive EPS performance will translate into an appreciation of the valuations of the company. From an investor's perspective, the company is showing a satisfactory performance.
Dividends: The Company pays no dividends on its stock and is not planning to pay in the near future. This is typical dividend behavior of stocks from growing industries. The company needs to capitalize on future growth by retaining its earnings.
To summarize, the recent financial performance of Baidu is impressive and proves that the company is the most dominating internet search service provider in the Chinese mainland. The company is enjoying growing revenues, high margins and has ample cash to cope with the future growth.
The Chinese internet penetration has yet to reach its full potential. With a penetration of around 42% there is still room for substantial growth. This growth factor attracts many internet platform service providers resulting in fierce competition. The fierce competition between corporations has resulted in Baidu losing some of its share but it continues to be the dominant player in the industry. Qihoo and others will bring strong competition to Baidu in the future, as they are doing now, and Baidu will have to counter their strategy. With such ample room for growth there could be space for more than one winner; being in the leading position right now, Baidu will probably be one of these winners. On the other hand, the relatively smaller companies, like Qihoo, do not have a chance for error and also Qihoo's marketing strategy could result in its downfall. This is why we believe that Baidu is still a safer bet as compared to the other competitors. The verdict on the stock of Baidu is a buy due to its financial strength and promising future. The potential reasons for Baidu's success, although discussed in detail above, are summarized below:
- The future growth potential of internet in China will derive Baidu's growth.
- Baidu's acquisitive strategy and the shift towards mobile market will assist Baidu attain future growth.
- The dominating market position of the company is an added advantage for the future.
- The historic performance and the current balance sheet outlook also indicate Baidu's potential to capitalize on future growth.
Significant Risk Factor: The entrance of Google in the Chinese search engine market will deteriorate Baidu's Market share, which could have long-term effects on the revenue and business growth of the company.
Additional disclosure: Equity Flux is a team of analysts. This article was written by our Technology analyst. 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.