Baidu (BIDU) was recently present at Deutsche Bank's "dbAccess Asia Conference" to meet with institutional investors. At the conference, the company:
- Addressed investors' concern over Q2's 56-60% y/y guidance with a positive tone by pointing out that the guidance reflects the higher base from last year when "hot money" from group-buy and ecommerce sites were channeled to online advertising
- Pointed out that it is attempting to grow its SME customer base without increasing sales headcount by working with distributor partners in lower tier (eg. Tier 2, 3 and 4) cities
- Highlighted that the company continues to depend on paid clicks (+54% y/y in 2011) as its top revenue driver, while cost-per-click is growing moderately (+10% in 2011)
- Said it has no plan to monetize its cloud-based offerings, which are predominately used by individual users.
- Said it may look beyond Dell (DELL) and Foxconn (FXCNY.PK) to expand its mobile OS initiative
In my view, Baidu's weaker than expected Q2 guidance is reasonable given the weak economic conditions in China. While I do not believe that China will experience a hard-landing scenario, companies are certainly cutting back ad spending due to uncertain macro conditions in Europe, which is one of China's major export markets. In addition, "hot money" from group-buy and the ecommerce boom of last year is declining as unprofitable sites shut down.
A growing SME customer base could be a challenge as majority of Baidu's 7,000+ sales force is based in Tier 1 cities, namely Beijing, Shanghai, Guangzhou and Shenzhen. While working with local distributor partners could alleviate cost pressure for the near term, investors should note that it is uncertain whether local distributors possess the same product knowledge and sales capability as Baidu's own sales force. Should distributor partners be ineffective in closing the sales quota, Baidu is likely to deploy its own sales force in these lower tier cities, hence increasing the pressure on the cost side.
Lastly, mobile search and OS will continue to be a challenge for the company as it is a late-comer into the space. Recall that Baidu's first mobile phone, the Dell Streak Pro D43, never really gained traction among Chinese consumers due to Dell's weak brand equity in the handset space. While Baidu's low-end ChangHong handset allows the company to enter the entry-level 1,000-yuan ($160) smartphone market, I pointed out in my May 19th note titled "Investment In Baidu Yi Likely Result In Cost Pressure and Margin Deterioration" that the product is challenged by over 300 other smartphone models from over 20 manufacturers that operate Google (GOOG) Android. An endorsement from a well-recognized OEM such as Samsung, HTC, or Huawei could boost Baidu Yi's credibility and image among the other Android forks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.