Why Baidu Should Be Bought On The Pullback

Aug.31.12 | About: Baidu, Inc. (BIDU)

It is always interesting to see what happens when momentum stocks slow down. While market leaders such as Apple (NASDAQ:AAPL) and Baidu (NASDAQ:BIDU) have risen on strong fundamentals, these companies are also momentum names.

Baidu rallied hard after over the last several months. While China's leading search engine company fell from around $160 a share late last year, to $100 a share several months ago, shares rebounded nicely over the last several months after the company's surprisingly strong recent earnings report.


Baidu shares rallied from around $110 a share in mid-July, to over $130 a share in mid-August, and the stock had significantly outperformed the S&P 500, and its tracking exchange-traded fund, SPY (NYSEARCA:SPY), over the last several months.

This is why I find the significant recent sell-off in Baidu's shares since mid-August on the news that the company may lose market share to new competitor, Qihoo (NYSE:QIHU), so interesting.

I recently wrote that I thought Baidu was a broken growth story, and the company's two biggest problems have been stagnating market share growth in search and mobile, and an inability to monetize the company's existing market share in these fast growing markets.

Baidu's market share nearly doubled in the Chinese search engine market from 2004 to 2009. With Google increasingly having trouble with the Chinese government and the Chinese online advertising space growing at 20% a year, Baidu significantly expanded its search engine in this fast growing market at the right time.

Still, with Baidu market share in the Chinese search engine market at over 80%, and China slowing, increasing concerns over the company's decelerating growth rate caused the stock to sell-off hard.

Qihoo 360 technology was a company competing primarily in the mobile space against companies such as Tencent (0700-07.HK) over the last several years, and the company recently launched its popular web browser on August 16. While conflicting reports exist, the consensus is that Qihoo likely has taken around 10-15% of the search engine market in China.

Still, Baidu's problem has been the company's inability to better monetize its existing market share in search, and management's struggles to increase and monetize the company's market share in the mobile space. Baidu has had over 75% of the Chinese search engine market the last several years, and the stock has gone nowhere.

This is why I think the recent sell-off over fears of possible market share loss is a buying opportunity.

Baidu's stock finally began to rebound after the company's critical recent earnings report. While the company's second fiscal quarter report did not show any market share gains in search or mobile, the company significantly increased its per ad fees this past quarter. Baidu's growth rate accelerated significantly this past quarter because of new and more targeted advertising revenue, and the company also further increased its existing advertising fees by focusing on smaller businesses and offering new forms of advertising methods, such as banner ads.

Baidu has been very successful at growing market share in the search space over the last decade, but the company's market share gains in search and mobile have been very minimal over the last several years. The critical challenge for the company now was monetizing its existing market share. Baidu showed it was better able to monetize its search and advertising revenue last quarter, and the company's growth rate accelerated to over 50% from first to second quarter.

To conclude, while Baidu was partially helped by an increase in advertising spending after the Chinese New Year, the company is showing strong ability to further monetize its existing market share, and Baidu's partnership with Apple could be significant with the new iPhone 5 launch if the company is better able to monetize the mobile advertising market. Baidu trades at nearly 18x average estimates of next years likely earnings, but the company is growing at over 40% a year. If the company's growth rate continues to accelerate the stock would likely trade at a growth multiple of 25-28x average estimates of next year likely earnings of $6.31 a share. That would make Baidu a $160-180 dollar stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.