Baidu (NASDAQ:BIDU) is the largest internet search provider in China. The company saw its stock price bounce back to $170 by mid-February after a ruling by an SEC judge in January pushed the stock down to $150. The judge banned the Chinese ventures of the Big Four accounting firms—Deloitte, PwC, Ernst & Young and KPMG—from auditing the financial statements of U.S.-listed Chinese companies for six months. According to the SEC judge, the four accounting firms violated the Sarbanes-Oxley Act that requires companies to certify the accuracy of financial data. The ban instilled a fear among investors that Baidu, which is audited by Ernst & Young’s China unit, may not be able to file its annual report in time. A situation like this can lead to a company’s shares being suspended from trading on U.S. exchanges.
The accounting firms filed an appeal against the ruling on February 12. Analysts expect that the ruling will take a long time to implement even if the firms lose the case and therefore, the 2013 annual reporting for U.S.-listed Chinese companies (including Baidu) should not be affected. Fading concerns over the suspension on trading has allowed Baidu’s ADR to regain its momentum that it acquired in 2013. Baidu’s stock price nearly doubled in the back half of 2013 to $182 driven by the factors we list below.
Factors Acting As Boosters For The Stock
1. Improving Monetization On Mobile: Baidu’s market share in the mobile search market increased to 38% in mid-2013 from 35% in 2012 as the company invested in various parts of the mobile ecosystem. The contribution of mobile to total company revenues also increased to 10% in Q2 2013, the first time ever in any quarter.
The improvement occurred as Baidu introduced an integrated PC and mobile bidding system last year, which contributed to increased advertising on the mobile platform. A nationwide search engine marketing campaign with heightened focus on mobile was also undertaken by the company to bolster the adoption of its mobile products. Further, the company acquired 91 Wireless Websoft—China’s largest third-party app distribution company—in a $1.9 billion deal to strengthen its app distribution capabilities.
2. Diversification Into Other Businesses And Away From Search Advertising: Baidu’s business portfolio is more concentrated on search advertising, which accounts for over 60% of its revenues and 50% of its value, according to our estimates. The company acquired Nuomi ($160 million for 59% stake) and PSS ($370 million) in 2013 to decrease its dependence on search advertising and diversify its business.
According to Dataotuan, Nuomi accounts for about 10% of the revenues of the local deals market in China. The deals website has been facing huge losses since inception due to intense competition. However, the sector is seeing a consolidation. We expect Nuomi to become profitable after the industry is left with only a few players. After the acquisition of PSS, an online video service commonly used in PCs, Baidu’s online video platform has also become the largest in China. According to a report by McKinsey, about 570 million Internet users in China watched online video content in 2013. The figure is expected to breach the 700 million mark by 2015.
Competition From Qihoo Poses The Biggest Threat To Baidu
Despite the positive developments that occurred in 2013, we think that the market is overvaluing Baidu’s stock. We have a price estimate of $143 for Baidu, about 15% lower than its current market price as we believe that rising competition from Qihoo is a major threat to the company. Launched in August 2012, Qihoo has already gained more than 24% share of the search market as measured by page views. Its management is targeting a share of 35% for 2014 and 40% for 2015. Baidu has a market share of over 60% in search. Going forward, we expect the company to concede some of its share to Qihoo.
Disclosure: No position