Baidu (NASDAQ:BIDU) is set to announce its Q3 earnings on Monday, October 29. It had a pretty good second quarter with revenue increasing to $860 million, up 60% year-over-year, and operating profit rising to $443 million, up more than 50% year-over-year. However, the company has taken a hit in stock price over the past couple of months, falling to $114 from a high of $130 in August.
Baidu has been surrounded by concerns relating to increasing competition in the Chinese search sector, which saw competitors such as Qihoo (NYSE:QIHU) launching new search engines during the quarter. This could have a downward impact on its margins and market share and so we will be closely tracking these two metrics during Baidu’s upcoming earnings. Additionally, we will also watch for data on Baidu’s mobile revenues which will be key in maintaining the company’s long-term growth rates.
Search Engine Market Share
Baidu posted strong EBITDA margin growth over the last three years, increasing from around 45% in 2009 to 60% in 2011. This increase was helped in part by Google’s troubles in the Chinese market, culminating in the firm’s exit in 2011. Google’s exit essentially gave Baidu a monopoly on the Chinese search market, a position that could wane as new competitors enter the industry.
For example, Qihoo launched a search engine in August that competes directly with Baidu.  If Qihoo’s search engine is able to grab a chunk of market share from Baidu, it would likely lead to a downside revision of our price estimate. We will be closely watching what Baidu’s management has to say about this increase in competition and the strategies it will try to implement to combat market share pressures.
We expect online ad spending in the Chinese market could grow at a slower rate than previous years due to a worsening economic environment. This combined with new competition that Baidu is facing could impact the company’s margins for two reasons.
First, the pricing power that Baidu enjoyed due to its near monopoly is likely to hinder the company’s ability to pass on cost increases to advertisers. If it is unable to charge the same premium for specific search keywords, we will see a decrease in margins. Second, we could see the Chinese Internet landscape become more like Silicon Valley in terms of competition for the best engineers; and with more competition for talent, Baidu will likely have to push salaries higher to retain employees.
Baidu has approximately 35% market share in the Chinese mobile search market, substantially lower than 80% share that it has in PCs and desktops.  This is a key avenue where Baidu will seek to expand in the coming years, but the relatively smaller market share compared to its PC offerings could leave the company in trouble. However, Baidu is taking initiatives such as launching its own browser to gain market share among mobile users. We will closely watch management’s discussion on mobile developments during the quarter to assess the long-term growth prospects of this revenue stream.
We currently have a $123 price estimate for Baidu, which is approximately 10% above the current market price.Notes:
- Qihoo Posts Record Gain on Competition to Baidu: China Overnight, Bloomberg [↩]
- Baidu’s Mobile Push: Not As Easy As It Seems, Seeking Alpha [↩]