Baidu's (NASDAQ:BIDU) shares now trade just barely above their 52-week low. The company has been hit especially hard by a weak Chinese stock market, slowing economic data in China, and competition concerns that a competing search engine by QIHOO 360 Technology (NYSE:QIHU), could impact revenues and growth rates for the company. But after reviewing the facts, I see that Baidu is grossly undervalued and makes a great stock for the savvy investor.
The decline in the Chinese stock market is a direct result of weak economic data that has been coming from that country. There are many reports that China is in the middle of a hard landing. Recent economic data however, shows that China has rebounded strongly. The "hard landing" talk spurred China to get more aggressive with economic stimulus projects, and it has paid off.
It is also important to realize that a slowdown in China is not necessarily equivalent to a slowdown in most parts of the world. While the country has become very used to seeing double digit growth quarter after quarter, the slowdown has meant growth "only" in the neighborhood of 7%. Most countries would welcome such a slowdown with open arms. You cannot stop the fact that China has a massive population and that a larger and growing part of this population are using computers and consuming online goods and services. This is continuing trend and shows no sign of stopping. To have a stock like Baidu trading at such low levels yet with the ability to capitalize long term on this growing might be the best opportunity an investor will see in years.
Qihoo 360 does present something of a challenge, but even the most positive of estimates has the company only garnering 20% or so of the market - not a real threat to trounce Baidu, and certainly nothing for investors to be overly concerned about. Baidu also starts with a huge cash advantage that it can take advantage of if the competition gets too fierce. Along the same lines Baidu owns a very big lead in infrastructure and engineering development, something that will take Qihoo years to catch up. Baidu is clearly the dominant search engine in China, and old habits die hard, so it seems unlikely for another search engine to unseat Baidu. In the United States, for example, a number of search engine companies have competed for market share, but Google (NASDAQ:GOOG) has done well in spite well-financed competition from Microsoft's (NASDAQ:MSFT), "Bing", Yahoo (NASDAQ:YHOO), and others. It is very difficult for a company to come in and instantly become successful in the search engine market, and even when there is success the dominant player still controls the market. This shows that there is room for some competition for Baidu, while leaving plenty of upside for it as the dominant player.
Baidu had a pretty good quarter recently as total revenues increased to $995 million, growing almost 50% year-over-year. It also reported a 50% year-over-year increase in operating profit to $525 million. The competition from Qihoo seems minimal at best on Baidu's bottom line. The company posted strong and encouraging numbers across its businesses, which leave it in a good position to weather the challenges of a competitive Internet landscape. Baidu had very impressive customer growth numbers for Q3. It had approximately 400,000 customers, which was a 30% increase year-over-year and a 10% increase quarter-over-quarter.
The fact that Baidu did a good job of attracting new customers during a quarter which, along with increasing competition, included concerns about the Chinese economy, is a testament of the company's capable sales force and its ability to handle a relatively difficult landscape. The firm continued to invest heavily in training and expansion of its sales team. These investments will continue to pay off huge dividends going forward. It is clear that Baidu's leadership in the market can be leveraged successfully by its sales force.
Baidu had approximately 35% market share in the Chinese mobile search market, which is substantially lower than its 80% share in PCs and desktops. This is a huge area of potential growth. The company is well positioned to expand in this area from its status as the market leader in the PC market. As the mobile market continues to expand in China I expect Baidu to increase market share and reap the huge growth in the area.
Baidu is also diversifying and will not be so reliant on its search engine going forward. Baidu's iQiyi video service is now the second most used video service in China. This is very good news for Baidu investors. An increase in iQyi's user base can be a big growth driver for the company's display ad division. Just like Google derives significant revenue from YouTube revenue, Baidu can increase revenue and diversify at the same time.
Chinese stocks will come back into favor and when they do Baidu will lead the rebound. Baidu trades at a ratio around 24, versus over 56 for Qihoo. That is very cheap for a company that could be poised to grow over 20% per year for the foreseeable future.
Given the state of the Chinese economy which will see growth of 7% and more going forward, along with the huge computer market that is growing very fast, Baidu is poised to see significant growth in its share price. When you factor in its cash advantage over its competitors, its engineering dominance and its ability to diversify in the Chinese market it is not stretching the bounds of credulity to expect this stock to see $200 in the coming year.