Why Baidu’s Stock Is Struggling Despite Its Cheap Valuation

by Trefis Team
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BIDU
Baidu
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    Quick Take 

  • Baidu’s stock has dropped by more than 15% due to decelerating growth, lowering operating margins and growing competition in the Chinese online search market.
  • While our valuation for Baidu represents more than 30% premium to the current market price, we also believe there are various risks to our price estimate.
  • Though Baidu’s topline grew by a strong rate of 42% in Q4 2012, it is also important to note that the growth rate almost halved compared to the previous year.
  • Baidu faces increased competition from newer players, such as Qihoo and we expect the competition to remain fierce.
  • Given Baidu’s low market share (35%) in the mobile search market and a growing trend towards use of mobile Internet in China, we expect these factors to weigh on Baidu’s earnings in the future.

Baidu (NASDAQ:BIDU) is the leading online search provider in China. Its stock has dropped by more than 15% since the latest earnings were released on February 4, 2013. Several factors contributed to the drop in the stock price including slower growth and increasing competition from Qihoo and others as well as mobile monetization problems.

While our $115 price estimate for Baidu’s stock represents more than 30% premium to the current market price, we also believe there are various risks related to investing in Baidu, which are discussed in this article. Baidu faces deceleration in its growth rate as its 42% top line growth in Q4 2012, was almost half as compared to the previous year. Its operating margin also contracted during 2012 on account of rising costs. Growing competition in the online advertising industry from newer players such as Qihoo and Baidu’s low market share in the mobile search market are further expected to weigh on the company’s earnings in the future.

See our complete analysis of Baidu here

Risks Related To Investing In Baidu

Decelerating Growth In The Top line Coupled With Narrowing Operating Margins

2011 2012
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Revenue (RMB billion)

2.44 3.42 4.18 4.47 4.26 4.46 6.25 6.34
Y-o-Y Growth 88.3% 78.4% 85.1% 82.5% 75.0% 59.8% 49.7% 41.6%

While Baidu’s top line grew at an impressive rate of 42% in Q4 2012, it is important to note that the growth rate almost halved as compared to the previous year. It is also interesting to consider that the growth rate in the Chinese Internet advertising market has comparatively slowed down after experiencing heavy growth over the past years. In 2012, the Chinese online advertising revenue rose by 47% as compared to a higher growth rate of 54% and 58% in 2010 and 2011 respectively, according to iResearch. [1]

The Chinese online advertising market is further expected to slow down over the coming years. During 2013-2016, the Chinese online advertising revenue is estimated to grow at a CAGR of 26%. [1] The factors that contribute to the decline in growth rate include maturing market, difficulty monetizing the mobile platform and macro headwinds in the Chinese economy.

Q1 Q2 Q3 Q4
Operating Profit Margin (2012) 49% 51.6% 52.7% 45%
Operating Profit Margin (2011) 49.1% 54.4% 53.3% 51.3%

The operating margins came down in 2012, and this is a worrying trend for the company. In Q4 2012, the operating margin was recorded at 45% as compared to 51.3% in the prior year. Interestingly, R&D expenses rose by 70% annually in Q4 2012, and we think these expenses will keep growing in the near term as Baidu counters rising competition in the market. We expect growing competition and rising costs to weigh on Baidu’s EBITDA margins over our forecast horizon.

Growing Competition In The Chinese Online Search Market

Baidu is the dominant player in the Chinese online search market with a market share of around 80%. However, the sector is witnessing increased competition with the entry of newer players such as Qihoo. Launched in August 2012, Qihoo has already gained 10% share in the market. Qihoo’s management plans to grow this share to 20% by the end of 2013 and 40% by 2015. [2]

Whether or not Qihoo is able to achieve its targets, we expect the competition to get fierce between the two companies, and this factor could weigh on Baidu’s profitability in the future.

Shift To Mobile Internet Presents Problems for Baidu

The Chinese Internet market is in the midst of a transition phase with increasing number of people accessing Internet via mobile. In 2012, around 75% of the total Internet users in China used mobile to access Internet as compared to around 69% in the previous year. [3]

This trend presents various challenges to Baidu, which has a much lower market share on mobile devices (35%). Also, the mobile search market is fragmented, with presence of players such as Tencent and Easou having market shares of 23% and 22% respectively. [4] While Baidu is aggressively taking steps to improve its mobile offering, we believe it will find it difficult to raise its market share significantly, given the fragmented nature of the market. Further, mobile platform also suffers from low monetization problems on account of smaller screen size.

China-Specific Risks

Since Baidu derives most of its revenues from China, it also faces various China-specific risks such as slowdown in the Chinese economy and adverse government Internet policies. In addition, while Baidu has not faced any accounting issues in the past, some investors worry about accounting problems with Chinese companies and this has negatively impacted Baidu’s stock in the past.

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Notes:
  1. China Online Advertising Revenue Impressively Increases 46.8%, iResearch, February 04, 2013 [] []
  2. China’s Qihoo takes aim at Baidu with aggressive goal to capture 10% of local search market per year, The Next Web, February 27, 2013 []
  3. China’s Internet population surges to 564 million, 75 percent on mobile, ZDNet, January 15, 2013 []
  4. Baidu’s Mobile Push: Not As Easy As It Seems, Seeking Alpha, April 4, 2012 []
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