- Margins will remain under pressure in the short term.
- The strategy to sacrifice short-term profitability for long-term growth will yield huge benefits.
- Baidu's mobile strategy will increase its market share in the segment.
Baidu (NASDAQ:BIDU) finished the last year strongly, recording gains of over 70%. However, year-to-date, the stock is down over 11%. The fall in the stock price has been mainly due to the guidance about the margins - the company does not expect much growth in profits despite strong expected growth in revenues. However, I believe this fall is temporary and the stock should make a strong upward movement over the next few months. The long-term strategy of the company is very impressive, which will make it one of the best picks in the sector.
Focus on the Long-term Growth
The mobile app store was one of the driving forces behind the profit for Baidu in the last year. According to the company filings, the mobile segment accounted for 20% of the total revenues of the company. These revenues will grow further as the company focuses on increasing its footprint in the mobile segment. As I mentioned in my previous article, the company will be focusing on further investments in the segment over the next few months. As a result, the cash generated will be most likely reinvested in the business. Furthermore, the company has been investing heavily on the marketing, advertisement and promotions.
Baidu is paying several mobile manufacturers to pre-install their apps in the upcoming smart phones - it is an important strategy to penetrate the mobile segment as the pre-installed apps will increase the footprint of the company. The seven apps include, Baidu search app, Baidu Mobile assistant, Baidu Browser, Baidu IME, Baidu Mobile Guardian, Baidu Map, Baidu Cloud and Noumi. The first two apps would serve as a major asset in cash generation through search advertising and app distribution. The next three apps, that is, Browser, IME mobile guardian, may not generate cash directly. However, it would be a healthy contribution to Baidu's market capturing strategy and would strengthen its position in the market.
Baidu Map already has a market share of 26.6% after its robust growth in the previous year. Baidu Map is the second largest location service provider following AutoNavi, which has a market share of 31.3%. I believe that the strategy of pre-installing the app would further increase its market share of location services. Baidu cloud also has a lot of potential to grow - Cloud computing is a hugely lucrative segment and Baidu's strong position in the Chinese market will allow the company to exploit the cloud segment. Alibaba group is a direct competitor to Baidu in this business segment and they have been at war for quite some time. Through this app, the company can increase its market share, which would result in greater revenues and profits in the coming years.
The strategy of sacrificing short-term profits for the long-term growth will yield substantial benefits for the shareholders. The company has been spending heavily on the promotional activities in order to capture a larger market share, and the investment in these activities will continue. As a result, margins will be under pressure in the short term and we will not see the stellar growth in revenues completely transform into higher margins. However, in the long term, we will see solid margins that the company will be able to sustain.
As I mentioned above, the growth in revenues has been extremely impressive for the company over the last few quarters. However, due to the operating expenses rising at a higher proportion than the revenues, the operating margin has fallen for the company - operating margin for the last year stood at 35%, down from 52% at the end of 2011. The company is again expecting 50-60% growth in revenues; however, the margins will not improve in the short term as the operating expenses will continue to grow. The same trend is present in the net profit margin, which has come down from 45% at the end of 2011 to 32% by the end of the last year. In the medium term, however, the margins will show strong recovery as the marketing and promotional expenses will grow at a much slower. Trailing twelve month P/E ratio of Baidu is currently 49.5, which is above the industry average of 42.6.
The long-term growth prospects of the company are clear, in my opinion. The revenue is still growing at an impressive rate and the focus on the mobile segment will further enhance the growth in revenues. Furthermore, the strategy to capture a larger market share at the expense of short-term profitability will give the company a platform to continue its impressive growth in the long term. I believe Baidu is an attractive long-term investment.