Just recently, Baidu (BIDU), China's largest search engine, announced it will be inking a deal with Apple (AAPL) wherein the iPhone maker will add Baidu search engine capability to its handsets.
While Baidu already controls 80% of the search engine market share in China, this deal will allow the company to grow more as the number of searches increase. So even with 80% market share, how can Baidu grow with Google (GOOG) still being a major player in the space?
Last quarter, Apple sold 35.1 million iPhones in China. That's an 88% increase from the year before. Like many other developing countries, China is seeing more people with smartphones than with laptops. This is due to purchasing power and efficiency. Income levels in China are much lower so you will are less likely to see someone from a poorer background with a Macbook Pro. Rather, smartphones are efficient as they allow for communication as well as surfing the net.
So those individuals with only smartphones will now be able to access Baidu from them instead of defaulting to Google.
Here is a breakdown of why a $150 price target is reasonable based on the current news. A $150 price target implies a market cap around $52.5 billion. With the iPhone growing strongly in China, the Baidu search engine feature will continue to see a rapid increase in searches. Google's built in search engine will slowly die out. This is not because Google is a bad search engine, but rather Baidu is able to appeal to the Chinese audience for various reasons. The biggest reason is being that most people in China do not speak English.
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China recently just surpassed the U.S. in smartphone activations in Droid and iPhones. 13.4% of China's population uses iPhones and that number will grow with the Baidu deal. Chinese speaking individuals will have an easier time searching with this Chinese-language feature.
Currently, analysts expect Baidu to earn around $6.38 per share. This estimate is without the deal inked with Apple. Now with the deal, Chinese speaking individuals will be able to use the Baidu feature. Market share for iPhones would increase as these users make the switch. Last week, Baidu also announced that it would compete with Google by having features such as Baidu Xiangce, a file sharing site, on Android phones.
With these recent deals coming to light, I estimate that Baidu will be able to grab at least half of Google's market share. That's an estimated additional 7%. So that would take Baidu's share to 87%. That's not much of an increase, except we are forgetting to add one more thing into the equation. There are still more than 700 million people in China without an Anroid or iOS phone. That will change very soon.
I estimate that Baidu will earn roughly $11 - $13 per share by 2014. At a $150 per share, this implies a P/E of 11.5. This is on the following assumptions:
- Baidu grabs half of Google's market share
- In the next two years, 100 million more Chinese consumers purchase a smartphone with Baidu capabilities
These are reasonable assumptions, and to be honest, this is very likely to occur. The big issue will be, even with all these users, whether Baidu will be able to monetize on the growth.
I believe it can based on the current valuation. The company has a market cap around $43 billion. That's pretty low for a company that nearly controls the entire Chinese search market. Keep in mind, only a third of the population also has access to online services such as Baidu.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
