While Baidu's (BIDU) name may represent the persistent search for the ideal, the Chinese Internet search company may have less-than-ideal results when reporting its earnings on July 23, 2012. The Chinese economy has slowed, and for the second quarter of 2012 possibly less than the official 7.6% growth rate. Add Europe's turmoil to the equation, and Baidu may not have fared as well as some expect.
Baidu's competitor Google (GOOG) reported good earnings yesterday with yearly revenue growth of 35% year over year and 15% quarter over quarter. However, Google does not have as much exposure to China as Baidu, so using Google as a gauge for Baidu's performance is not a good comparison.
Baidu noted in its Q1 2012 earnings call it had achieved robust expansion for its Small Medium Enterprise (SME) customer base, despite a seasonally slow quarter. The company continues to push it Box Computing initiative, which enables third-party developers to develop features that are "outside of the box." Developers have created over 70,000 applications that are available to users. The company launched personalized homepages in September of last year, resulting in improved "stickiness" of its users. Baidu recently hosted its first-ever Developers Conference in order to promote open platforms. The theme of the conference was web application design and delivery of mobile Internet applications.
During the earnings call, the company estimated its year-over-year growth outlook for Q2 as between 56.2% and 59.9%. With the slowing Chinese and European economies, Baidu's estimates look high from this vantage point.
Baidu's stock price has been significantly down over the last four months, as shown below:
Some of the Chinese and European economic slowdown may already be baked in to Baidu's stock price, but the company's stock price does not appear to have formed a base as yet. With a price-to-sales ratio of 19, Baidu's stock prices looks very expensive at this point.
To protect a long stock position in Baidu, an investor might consider entering a protected covered call or collar in order to position for a potential return, yet protect against a significant drop in stock price. A protected covered call may be entered by selling a call option against the stock and using some of the proceeds from selling the call option to purchase a put option for protection, or "stock insurance."
Using PowerOptions tools, a number of protected covered call positions are available for Baidu as shown below:
Click to enlarge image.
The second-highest protected covered call looks attractive, as it has a potential return of 2.8% (146% annualized) with only seven days to expiration and has a maximum potential loss of 6.5%. So, even if the stock price drops to zero, the maximum loss that can be sustained is 6.5%. The specific call option to sell is the 2012 July 110 at $5.15 and the put option to purchase is the 2012 July 100 at $1.41.
Trade
- BIDU stock (existing or purchased)
- Sell BIDU 2012 July 110 Call at $5.15
- Buy BIDU 2012 July 100 Put at $1.41
The highest protected call is also attractive, but the time frame for holding is longer at 29 days, as compared to seven days for the second-highest returning position.
A profit/loss graph for one contract of the Baidu protected covered call is shown below:
For a stock price below the $100 strike price of the put option, the value of the protected covered call remains unchanged. If the price of the stock increased to around $125, the position can most likely be rolled in order to realize additional potential return.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
