Chinese search giant Baidu (NASDAQ:BIDU) has gained some momentum after reporting its first-quarter results at the end of April. The stock is up 6% this year and trades close to its 52-week high. However, under intense competition from Qihoo 360 Technology (NYSE:QIHU), will Baidu be able to sustain its performance after losing its market share in the last one year?
A good start
Baidu management issued a strong forecast for the second quarter, indicating the company is set to continue its momentum going forward after a good beginning to the fiscal year. In fact, Baidu had seen a massive year-over-year jump of 59% in revenue in the previous quarter, while its operating margin of 25.8% surprised the Street, helping Baidu improve its earnings. The company reported earnings of $1.23 per share, which was better than the estimate of $1.04 per share.
The company is seeing tremendous growth in the number of people accessing its Internet search engine through mobile, leading to an increase in advertisement spend. The company's average revenue per advertiser increased around 44% during the first quarter, which is remarkable. Also, Baidu had 446,000 active online marketing customers in the first quarter, which is an increase of 8.8% from the year-ago period.
Going forward, Baidu expects its online search business to expand in both PC and mobile. Moreover, as consumers shift from PCs to smartphones, Baidu expects to gain further due to its solid product development moves.
Product development focus
Baidu is making important changes to its products, allowing for faster load speeds. It is also enhancing its ad format on the search page. The company has made available customized vertical results for healthcare, e-commerce and education on mobile, which was previously available only on PC. Moreover, its search app has been the largest and fastest growing source of mobile search traffic and daily active users.
As already mentioned, its advertisement business is gaining momentum. To boost its business in this direction, Baidu has updated its bidding system. This new feature will allow customers to target users in specific cities rather than at a provincial level. Now, since ads are focused on a specific area, they will generate a higher return on investment for customers and also enhance the user experience. So Baidu can expect to see a bump in the number of advertisers.
In fact, Baidu has already started receiving strong feedback from customers, who received a good return on their investment through the mobile channel. Going forward, management expects that as customers see higher return on their investment, the company's mobile ecosystem will accelerate further.
Clearly, management is investing in the right avenues to improve the business. Baidu sees opportunity in five strategic areas - search, mobile and cloud, location-based services, consumer products, and international. Today, in China, Internet penetration is increasing at a much faster pace than in the developed economies. Baidu sees this as an immense opportunity to increase its revenue and earnings significantly.
As a result, Baidu is making strategic investments. During the first quarter, it acquired e-commerce website Nuomi, and renamed it Baidu-Nuomi. Baidu will leverage its resources to help Nuomi scale up quickly. According to management, "We are confident that Baidu-Nuomi is in a great position to lead China's growing group buying market."
In addition, iQiyi's performance was also very impressive during the first quarter. According iResearch, iQiyi is at the pole position in PC monthly and daily unique visitors, and also in both PC and mobile by monthly time spent.
However, Baidu is facing intense competition from Qihoo, which is making rapid moves to increase its market share in China. As I had written in an article back in April:
"Qihoo is engaged in a spending war with China's search leader, Baidu, to capture a bigger market share on both PCs and mobile devices. According to CNZZ, a Chinese research firm, Qihoo's market share has grown to 24.9% of the market in China, while Baidu's has fallen to 58.3%. Just last year, Baidu commanded a 70% share of the Chinese search market, but that has steadily fallen. As Qihoo continues to make more moves in the Chinese search market, Baidu could see its shares tumble further.
What's more, Qihoo has successfully managed to monetize its desktop search engine. Desktop search accounted for about 30% of Qihoo's business at the end of 2013, and since the company has continued to report strong gains in market share, this business should grow further."
Thus, Qihoo's increasing market share is a big threat for Baidu. In addition, Qihoo is already quite a big player in the Chinese Internet industry. There are 467 million smartphone users that use its flagship mobile security product, covering approximately 70% of the Chinese smartphone market. Moreover, monthly active users of its PC browsers stand at 354 million, accounting for over 70% of the Chinese PC Internet population. Hence, Baidu needs to keep an eye on Qihoo as it has the potential of eroding its market share.
Fundamentals and final words
Baidu is expensive at a trailing P/E of 36. But it has an outstanding forward P/E of 4, which is a sign that its earnings will improve in the future. Moreover, Baidu's balance sheet is quite strong. It has cash of $6.4 billion and a debt of just $2.91 billion. Cash flow generation is also strong, with operating cash flow of $2.44 billion in the last one year and leveraged free cash flow of $1.48 billion.
So, Baidu looks well-placed from a fundamental perspective. In addition, its product development moves also look impressive. However, considering the intense competition that Baidu is facing from Qihoo, investors need to be cautious while investing in Baidu.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.