Baidu: Don't Believe All The Hype

| About: Baidu, Inc. (BIDU)

Baidu, Inc. (NASDAQ:BIDU) is slightly overvalued and at a premium, and so there may be enough reasons for investors to explore the competition. The financials show that Baidu has benefited from strong positioning in the industry. The numbers also suggest that this prominence has been losing momentum with time.

Baidu is facing an increasing amount of competition in the desktop search industry, while it is struggling to establish a leadership position in the mobile search market. Despite new partnerships and product releases, shareholders should expect Baidu's rate of growth and earnings to decrease over the next few years.

Baidu's financials indicate that it is highly desired in the market by investors. Its beta is slightly below two, while the five-year expected ratio is close to a half. The current market cap is almost $3 billion more than the enterprise value. The price to sales ratio is over 16, while the price to earnings ratio is expected to decrease by nearly 50 percent to 18 times earnings looking forward.

Sales growth has increased in 2012 by over 98 percent from the previous year. Adversely, sales growth has decreased by nearly 5 percent since the previous quarter. Return on equity, operating margin and net margin have all decreased slightly over the past three quarters. Both the current ratio and quick ratio are both above 3. The current ratio has increased over the past three quarters. Baidu's debt to equity ratio has decreased marginally over the last three quarters as well.

Baidu's past and projected future growth rates each exceed the industry average. It should be noted that Baidu's projected growth rates are significantly less than the growth rates last year or over the past five years. The price to earnings ratio, operating margin and net profit margin are all significantly higher than the industry average. The price to book ratio is more than five times the industry average. The debt to equity ratio is also significantly lower than the industry average. Both the gross margin and institutional ownership exceed 74 percent. Both the debt to equity ratio and long-term debt to equity ratio are below 0.20.

Baidu recently announced it has reached an agreement with Apple (NASDAQ:AAPL) that will now have Baidu's search engine featured on the mobile devices. Baidu already has 80 percent market share in China, and hopes to gain more ground in the mobile market by contracting with Apple. Apple's sales in China have increased by over 85 percent from the previous year; last quarter, Apple sold over 35 million iPhones in China. More people are using iPhones than laptops in China because they are more economical, while providing communication and internet capabilities as well.

The ability to use Baidu instead of Google (NASDAQ:GOOG) as the default will help Baidu increase its market penetration with mobile users to an extent. Smartphone activations in China have exceeded those in the US; over 13 percent of the population in China now uses smartphones. Baidu also announced the launch of a file sharing site available on Android in order to compete with Google in the mobile market. Aside from the language application, Baidu is looking for additional ways to compete in growing mobile user market.

Apple will be sharing advertising sales as a part of the Baidu upgrade. This is deal is similar to the ones Baidu makes with multiple manufacturers that host the Android OS. Aside from the search engine, SIRI will also be available in Chinese. Baidu shares advertising revenues with manufacturers, websites and now Apple, it still divests less than 10 percent of its generated revenues.

Gaining ground on the mobile market is imperative in order to continue growth for Baidu. Nearly 80 percent of the smartphones with Android OS have Baidu installed as well. Baidu is trying to attract more mobile users by offering free service online like streaming music. Baidu's Cloud ROM, file storage software will allow Android users to store data or stream music from any location. Absorbing these costs in order to provide these services for free is part of Baidu's plan to compete in the mobile device market.

The inability to monetize or gain significant headway in the mobile device market is a factor impeding Baidu's projected growth in the future. Undoubtedly, there are macroeconomic obstacles in Europe and China as well. The slower internet in China currently hampers revenues from advertising contracts. Advertising growth in China has decreased by 10 percent the last few years as well. Baidu has 80 percent of the online search market, but only 35 percent of the mobile search market. The Apple deal may make Baidu more prominent but it will not increase revenues significantly.

Aside from Google, Baidu faces competition in the mobile market from Tencent (OTCPK:TCEHY) instant messaging service and Sohu's (NASDAQ:SOHU) search unit. Tencent has a niche in social networking applications that Baidu isn't necessarily prepared to compete with. Baidu has plans for its own smartphones, but it lacks the applications to make it truly competitive with other manufacturers. The inability to dominate in the mobile industry will impede Baidu's growth significantly looking forward.

Baidu recently tried to acquire Sohu's search unit, but that attempt was denied. This search unit is becoming viable competition for Baidu in the search and mobile markets. The Sohu search unit and browser is becoming more prominent in the market and creating competition for Baidu. It is the second largest search engine in China, while offering a browser and Chinese character input software as well. These additional services are becoming the differentiating factor for most Chinese users as the two leading search engines become more comparable. The Sogou Browser is the third most popular browser in China behind Internet Explorer and competitor Sogou's revenue growth has doubled Baidu's over the past few years.

Baidu is still the dominant player in the market, but the increasing degree of domestic and foreign competition, along with the inability to capitalize on the mobile markets, will impede the recent history of growth and prosperity that shareholders have grown accustomed to from Baidu.

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