Baidu Remains The Clear Favorite

| About: Baidu, Inc. (BIDU)

Over the last few months, Chinese internet stocks have taken a wild ride. Being high beta names, they have seen large price swings given the volatility in the markets. But they've also seen wild swings due to the ever present fear of Chinese government regulation as well as accounting and fraud fears, brought on by accounting investigations from U.S. government agencies. These stocks took a tumble in late September, and while they've rallied since then, we don't have an all clear sign on the industry. Not yet anyway.

So what to do with these names? In this case, size does matter-- which is why if you want to be in, Baidu (BIDU) is your best bet. Baidu trumps the two other large Chinese internet names, Sina (SINA) and Sohu (SOHU). It is also much better than the three hyped Chinese IPOs from the past year, Youku (YOKU), Dangdang (DANG), and Renren (RENN). As you can see from the following table, Baidu has a market cap that's 4.5 times the size of five other Chinese names combined.

Name Mkt. Cap. 3-month 6-month
Baidu $45.56B -9.13% 5.93%
Sina $4.08B -40.90% -31.96%
Sohu $1.99B -30.28% -25.88%
Youku $2.27B -6.52% -39.55%
Dangdang $412M -25.61% -63.12%
Renren $1.44B -46.74% -59.87%

Because Baidu is the largest, it has been able to withstand the scrutiny that many of these names have faced. The last three names on the list all came public in the past year or so, all with great hype. Youku is an internet television company, considered to be the Youtube of China. Dangdang is an online retailer in China, and Renren is a social networking site, the Facebook of China. These three names were supposed to be the best things out of China since sliced bread. Their performance lately has been terrible. They still have plenty of growth ahead, but investors have wanted more, so disappointment abounds.

Sohu and Sina have been around for a few more years, but their grouping into the Chinese Internet category has led them to fall in tandem with the other names. These two names are more established, with revenues growing in the 20% and 30% ranges, rather than the 80% and 100% numbers shown by the three I mentioned above. Sina has recently fought off rumors that Muddy Waters, an outfit that comes out with bad news on a name and then the stock price drops, was about to publish a report on the firm. The company has fought off these rumors, but the stock has struggled, down 2% in the past two weeks and unable to take part in the recent global rally (Baidu is up about 9% over that time). Both names remain buys/holds in analyst minds, and current price targets imply huge potential upside for both, 79% for Sina and 55% for Sohu. However, they also have the ability to drop plenty, as we've seen in recent months.

Before I discuss Baidu as the favorite, let's look at the potential future growth in all of these names.

Potential Revenues EPS
Name FY 2011 FY 2012 FY 2011 FY 2012
Baidu 86.2% 51.2% 92.8% 48.8%
Sina 21.2% 24.5% -46.2% 55.9%
Sohu 38.2% 26.0% 26.8% 17.9%
Youku 138.2% 84.6% * *
Dangdang 61.2% 58.1% * *
Renren N/A 49.7% * *

*Youku loss expected to narrow from $0.53 in 2010 to $0.21 in 2011 and $0.10 in 2012. Dangdang expected to go from 2 cent profit in 2010 to 33 cent loss in 2011 and 52 cent loss in 2012. Renren expected to have 2 cent loss in 2011, while both 2010 actual and 2012 estimate were for zero profit or loss.

That chart should tell you that Baidu is the favorite going forward. First of all, Baidu carries the least risk, as you saw by the first chart I detailed. While others are falling around it, Baidu is holding up quite well. Anyone that got in after the 2005 IPO is smiling now (split adjusted prices then were less than $10). The stock currently remains an analyst favorite, with 27 buy ratings and just 6 holds. The average price target is about $189, which implies about 45% upside from here.

We all know that Baidu is the Google (GOOG) of China, so let's look at the two. Baidu's market cap is only about a quarter of Google's, and Baidu's trailing twelve month revenues are just 1/18 of Google's. Net income is about a tenth. Despite carrying a $45 billion market cap, Baidu is still expected to grow revenues and EPS by about 90% this year and 50% next year. You won't find that many companies of that size growing that fast. Baidu has taken off in the past few years, and the stock has doubled since it executed a 10 for 1 split in May of 2010. Maybe Google should think about that idea, eh?

Some may question the lofty valuation Baidu carries, having a trailing P/E of 50 and a forward P/E of 30. But when you consider the growth potential ahead, it's not too bad. Remember as well, Baidu's gross margins are about 80%, while operating margins are about 52.5%, and net margins are in the 45% to 50% range. All three of those are higher than the other Chinese internet names-- and well, also a bit higher than Google's.

Baidu is up 20% over the last twelve months, while its peer group above has seen their shares plummet. It has had some rough patches when other names have gotten beaten down, but shares have held up extremely well. There is plenty of room for this company to grow, and it's growing profits as well as revenues. Yes, I said profits. Baidu is extremely profitable right now, something names like Youku and Dangdang aren't. There have been no accounting issues or even hints of anything suspicious going on. Baidu has the least risk of all the names, and may even have the most long-term upside. I like the name, but given the recent rally, I'd say you can get it cheaper than current levels.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.