Baidu (BIDU) has been swimming through volatile waters recently, trading above $120 in late August and dipping lower than $107 intra-day in September. The slump has been due to analyst downgrades, general negative pressure on ADRs and some news that has come out about Baidu's competitive position. I've made a couple trades around these momentum swings, but I thought it was time to take a step back and figure out what sort of sentiment we're seeing around Baidu, and what it tells us about the stock longer term.
Recent Analyst Skepticism
Jefferies lowered their price target on Baidu from $150 to $135, although they reiterated their buy rating on the stock in a research note sent to investors last Friday, September 21st. The concern was focused on Baidu's ability, or lack thereof, to convert mobile search to revenue. In the second quarter of 2012, Baidu revealed that mobile search accounted for a 20% of their traffic, but only single digit in terms of revenues. Jefferies mentions that a new version of their mobile browser will attempt to make it more difficult for rival Qihoo to duplicate their search efforts on the mobile platform. This will be coupled with mobile map traffic conditions and other location specific services that can be monetized in the future, according to Baidu management. The question remains, however, whether they can truly capture these future revenues if they aren't doing so today. Although Baidu has been very successful in their PC/desktop pursuits, their mobile endeavors have been mixed. It is difficult to increase revenues off the same volume unless you can truly revolutionize your monetization efforts.
Speaking of rival Qihoo (QIHU), Deutsche Bank offered some insights into Baidu related to their smaller foe in a research note sent out on September 19th. They performed a series of checks on search market share that revealed the following:
Our recent round of channel checks suggests that Qihoo's search share increased slightly (1-2 percentage points) since our last round of channel checks on Aug 27. We found Qihoo's traffic share gain mostly coming at the expense of Baidu. We estimate Baidu and Qihoo's market share to be 75-80% and 5-10% respectively vs. 80-85% and 0% prior to Qihoo's search engine launch. Although Qihoo gained search traffic share across a broad range of websites, its traffic share remained slightly below the first peak on 21 Aug among 40% of our surveyed websites. We attribute the rebound in Qihoo's search share to the conversion of more Qihoo browser users to Qihoo's search engine.
Baidu has already shown its weakness in terms of the mobile search, with competitors like Easou, SoSo (Tencent) and Google (GOOG) holding over 50% of the market share. If they begin to falter in terms of their desktop search share, then analysts may begin to wonder about their long term viability. There have been plenty of early stage market leaders that have failed during the relatively short life span of the internet. Former titans like Yahoo have been relegated to the peanut gallery in many ways. However, the growing internet base in China still provides plenty of potential for Baidu to break their own records in terms of revenues as the largest population in the world becomes more and more wired.
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As you can see from the analyst table above, the analysts have been giving mixed signals over the last few months, with a couple negative updates in the last seven days.
Baidu, in my eyes, is still a growth story associated with the advent of Chinese internet and web use. The growth is still definitely there, as Q2 earnings showed. However, they have also shown weaknesses recently, whereas they previously seemed as though they were invincible market leaders (a "Chinese Google"). I wrote about the headwinds they are facing in an article here. These have been most pervasive in the mobile sphere, where management has repeatedly said efforts will be made to improve monetization. So far, these efforts have been less effective than hoped.
As you can see in the US, mobile browsing of the internet (tablet and phone) is the way of the future, so Baidu investors have the right to be concerned. The ability to capture traffic revenue from Apple and Android powered devices will be crucial (20% of Apple's sales are already in China). So far, Baidu has not been as able to dominate the mobile sector as much as they have with PCs. I think that this is why sentiment is lukewarm around the company a month ahead of their Q3 earnings release.
If you are bullish on Baidu, then you have to be optimistic about their opportunity to maintain their share of the web based search, which will remain their core revenue generator for years to come. Qihoo's aggressive bites out of the search market share show that although Baidu is still an incredibly strong market leader, there are holes in their armor that competitors might target. After that, you have to assume that they will at least improve their ability to monetize mobile and fend off competitors that have shown an ability to take share from them. You also have to believe that they can rein in their TAC (Traffic Acquisition Costs) as they diversify their product offerings across more than just personal computers. These are all major assumptions.
Earnings come out in about a month. I anticipate that Baidu will react violently to this news, especially giving the downward pressure we're seeing on the stock from well known analysts. The stock is "undervalued" compared to previous levels, but it is the future prices we're worried about, not where it was a year ago. I believe that there is still significant upside to this trade, but you'll have to be willing to pay for a growth story. This isn't a conservative play.
The stock is holding up around the $105 level and encountering resistance 15% above that. However, their revenues are still growing at a pretty incredible rate and BIDU has traded about $150 before. If you're bullish on this next earnings release, it might be a good entry point if there is more negativity this coming week. As we've discussed, however, there are some risks associated with this stock and questions that still need answering.
Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.