Baidu Still A Good Buy Even With Downgrades

| About: Baidu, Inc. (BIDU)
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Baidu (NASDAQ:BIDU) is an internet company that offers a Chinese language search engine. Baidu's headquarters is in Beijing of The People's Republic of China. The company has a market cap of $34.8 billion, and its stock price is around $108.

Baidu is an internet search engine company that many Americans have dubbed as the Chinese Google (NASDAQ:GOOG). Baidu, like Google, attracts millions of users that want to browse the internet. Baidu makes money by collecting advertising fees from companies that want to sell products and services to those users. As of mid 2011, Baidu had the world's largest internet user population with 477 million people. Up until June of 2011, Baidu had been a hot internet stock. Investors were attracted to its ferocious level of growth, and to its potential to tap into the huge Chinese population. In the two years prior to June of 2011, Baidu's stock price had increased by 463%. But, since June of 2011, the stock's price has slipped. Surprisingly, slower earnings growth was not the reason. In the second quarter of 2012, the company reported revenues of $858.7 million which was a year-over-year increase of 62.5%. The company's second quarter earnings per share were $1.24 which was a year-over-year increase of 72%.

There are two reasons for the decrease in the stock price. The first is a lack of trust regarding the accounting reports from Chinese companies. In June of 2011, the Muddy Waters Research firm put out a report which basically said that a Chinese tree growing company Sino-Forest (TRE) had been "cooking its books to show more assets and earnings than actually existed, likening the company to a Ponzi Scheme." Muddy Waters shorted the company; its report was not designed to inform investors but to scare them. The stunt worked; the report was released on June 11th, and by August 25th Sino-Forest had lost 90% of its value and was delisted.

The Sino-Forest scandal pushed investors to distrust the reporting practices of Chinese companies, the stock of small Chinese companies, and, to a lesser extent, large Chinese companies were hurt. In the 10 days following the release of the report Baidu's stock price dropped 17%. Renren (NYSE:RENN), the Chinese Facebook, saw its stock price drop by 73% from June 1st to the beginning of 2012, while Sina (NASDAQ:SINA), a Chinese media company, saw its stock price drop by 53% during the same period. Baidu's stock, which celebrity stock analyst Jim Cramer said is the "only Chinese stock that he trusts", and which was better established, fell 14.8% during the same period. I believe that while Baidu has a clean reporting record, some investors are still wary of it because of its Chinese management.

The second reason that Baidu's stock has dropped in price is because of increased competition. In March of 2010, Google closed its internet search engine on mainland China due to China's government censorship rules. With the exit of Google, it seemed that Baidu would be the dominant and unchallenged search engine company of China. But, a new company named Qihoo 360 Technology (NYSE:QIHU) has now emerged. Qihoo is growing fast and has managed to increase its percentage of the Chinese search market to above 9%. Most of Qihoo's growth has come at the expense of Baidu.

Recent News on Baidu

In recent weeks, Baidu has gotten a slew of downgrades. On October 9th, Baidu stock price fell 7.3% after receiving yet another downgrade, this time from Credit Suisse. The firm, which now rates Baidu an Underperform, expects estimates to move lower thanks to stronger competition (no doubt from Qihoo), a weaker-than-expected ad market, and mobile monetization challenges.

On October 2nd, this announcement was made: "The Street seems to enjoy criticizing Baidu (BIDU -0.9%) these days almost as much as it enjoys praising Apple. A day after Jefferies downgraded Baidu, Raymond James is doing the same, though its rating merely goes to Outperform from Strong Buy. RJ points to Hitwise data that shows Baidu had 58.3% of the Chinese search market as of mid-September, down from the low-to-mid 60s before Qihoo's (QIHU +5%) arrival."

On October 1st, Baidu's stock slid after receiving a downgrade to Hold from Jefferies' Cynthia Meng. Like many other analysts, Meng is worried about Qihoo's (QIHU -1.1%) search engine: she thinks Baidu's Q3 results will be at the low end of its guidance range, and that its numbers for Q4 and later could miss Street estimates

On September 18th, Deutsche estimated that Qihoo had taken 5%-10% of the Chinese search market since entering last month, after surveying referral traffic at Chinese sites. The gains have mostly come at the expense of Baidu , whose share is believed to have fallen to 75%-80% from a prior 80%-85%. Deutsche naturally attributes Qihoo's gains to its ability to get browser users to try out its search engine.

On September 17th, a Chinese government report claims 54% of the country's mobile Web users have installed startup UCWeb's browser; at least a third use one of Tencent's (OTCPK:TCEHY) browsers; and 47% use their phone's default browser (clearly a lot of users have multiple browsers). The stats demonstrate the value to Baidu , which just released its own browser, in acquiring UCWeb, as the company is reportedly interested in doing so, for the sake of strengthening its mobile search hand.


In just the last month, a number of research houses (including Raymond James, Jeffries and Deutsche) have downgraded Baidu. The downgrades have taken a toll on Baidu's stock price, and on October 9th it fell by 7.3% after a downgrade by Credit Suisse. The primary reason behind the downgrades is that Baidu is losing search engine market share to its new competitor Qihoo. I disagree with the downgrades because Baidu is clearly still China's dominant search engine provider, and it has begun to branch out in the same way that Google did. It just "launched a new browser for mobile devices running on the Android operating system, that allows users to play games and watch videos without a media player", and it plans to spend $1.6 billion to establish a Cloud Computing Center." I would not give up on Baidu. I think that with year-over-year revenue growth of 60% and a price to earnings ratio of 27.7 that the stock is relatively cheap.

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.