Why Baidu Could Jump $50 By Next Summer

May.24.12 | About: Baidu, Inc. (BIDU)

Baidu (NASDAQ:BIDU) has reported total revenues for the first quarter of 2012 of approximately $677 million, which is an increase of 75% from the same quarter of the previous year. Operating profit was also up 75% from the previous year to $332 million. Attributable net income was up by the same percentage to $299 million. Diluted earnings per share for this quarter were $0.85 per share. For the second quarter of 2012, total revenues are expected to be in the range of $847 million to $867 million.

Because Baidu is arguably the most popular and widely followed Chinese stock in the United States as well as the world, it would be useful to know something about its background and its markets. Baidu is often regarded as the Google (NASDAQ:GOOG) of China, though it has branched out into many Internet-related areas in an effort to cement its dominance of the search business in China. In fact, Google used to compete actively with Baidu, but rather than deal with excessive government interference and regulation, it has chosen to move the core of its operation to Hong Kong leaving Baidu to monopolize the Chinese market. Internet penetration in China is under 40% of the population and, given the size of the population, the untapped population of potential use users probably exceeds the entire population of the United States. However, this is a simplistic comparison because much of the Chinese population is based in rural areas where people do not have a high disposable income.

However, the maximum potential growth lies in the emergence of the middle class, and a report suggests that in the space of a single generation, the Chinese middle class will be roughly 400% larger than the American middle class. Baidu has taken a number of steps to enlarge and solidify its monopolistic position in the search business. For instance, last year it acquired Qunar, a leading travel search engine. Earlier this year, it launched a platform from which to develop cloud computing services WangPan. In emulation of the successful strategy implemented by Apple (NASDAQ:AAPL), it has launched an application's store for third-party applications that can be launched on the Baidu website and read revenues are shared with the developers. It is clear that the company has moved swiftly and surely in every area that could have an impact on the success of its core search business.

Baidu has also made bold and aggressive moves to establish itself in the largest mobile device market in the world, and it is worth taking a look at these initiatives. In partnership with Foxconn (FXTCF.PK), it has unveiled the first smartphone to be built on its own platform, the Changhong H5018. Forked android mobiles are very popular in China and this phone follows suit. Baidu says that it wants its platform, the Baidu Cloud Smart Terminal to sit on top of all mobile operating systems including Windows Phone and iOS. Mobile is a big and growing market for Baidu because 20% of all its searches are now coming from mobile devices and it is by far the leading search engine for all Android devices in China. At the same time, China has now become the largest smartphone market in the world. The phone is priced at around $160, which is affordable for the large majority of Chinese consumers who cannot afford the iPhone. There is a large potential market because it is estimated that over 1 billion users use mobile phones that cannot take full advantage of the Internet and could be induced to trade up to smartphones.

Moreover, the phone is likely to be sold through resellers (the first carrier is China Unicom), will formulate data and calling plans and subsidize the cost of the device to the consumer. The company says that it has been able to keep the cost down because the services are being delivered on the cloud and devices do not require much processing power. Among the services will be a storage service, location-based services and Baidu Map, voice recognition and handwriting-based search input, Baidu Music and services for call and data credit recharging. The choice of its manufacturing partner is also interesting because of its partner' s involvement in the manufacture of the iPhone as well as the iPad.

There is every chance that Baidu will succeed in its mobile venture and create a distinctive market niche that could spur future growth. And in my opinion, the strategy formulation and execution has been flawless. But let's deal with the two major criticisms of the Baidu growth strategy. The first one is that the company has blindly copied the business initiatives established by Google. I think that this criticism has been refuted by the undeniable success of the company in its chosen market. The second criticism is that Baidu focuses entirely on China to the exclusion of the rest of the world. I see no problem here because the Chinese market alone is large enough to satisfy the most demanding of companies. Moreover, there is every chance that whatever works in China can be extended to other developing markets in due course.

The only major problem with Baidu as an investment is the overwhelming role of the Chinese government in its success. However, this could also turn out to be a strength because the Chinese government, far from harming business prospects, is quite likely to go out of the way to encourage growth. There are few stocks in the world that can match Baidu when it comes to market dominance and growth prospects. I would regard the stock as a strong buy. The current earnings multiple undervalues the stock considerably. Even if you are not inclined to buy at this point in time, you should most certainly hold on to any existing investment that you may have. Baidu is currently trading around $117 at the time of writing. Based on my analysis above, I predict the stock will climb to $170 and maintain that price level by mid-2013.

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