Baidu (NASDAQ:BIDU), the leading online search provider in China, will report its Q2 2013 results on July 24, 2013. The company’s stock has been under pressure this year due to concerns related to increasing competition from Qihoo, lower profitability and weak mobile monetization. We will look for any updates by the company’s management regarding these challenges as they are important for Baidu’s future growth.
Baidu’s latest move to acquire 91 Wireless Websoft could strengthen its position in the rapidly evolving Chinese mobile Internet market, and new details regarding this deal are awaited from the earnings call.
We expect the company to post high growth in top-line during the second quarter, however, the growth rate has slowed down as compared to previous years. Profitability concerns could remain as Baidu continues to invest in infrastructure, R&D and marketing activities to bolster its mobile product portfolio and enhance its adoption.
Recap of Q1 2013 Results
Baidu posted revenue of $961 million in Q1 2013, which represented an y-o-y increase of 40%. While the top-line growth seems impressive, it has slowed down considerably from 75% and 88.3% levels seen in Q1 2012 and Q1 2011 respectively.
With the Chinese economic growth slowing down in the second quarter of 2013 , we are keen to understand how this is impacting the macroeconomic fundamentals in the Chinese Internet advertising market.
Baidu’s operating margin declined sharply from 49% in Q1 2012 to 37% in Q1 2013. Rising competition in the Chinese online search market and ramp up of Baidu’s mobile strategy, caused R&D expenses and SG&A expenses to rise by 83% and 77% annually respectively.
Profitability Will Be Closely Watched In The Second Quarter
Profitability will be keenly tracked in Q2 results as low profitability in Q1 2013 had led to a decline in Baidu’s stock price. We expect Baidu’s operating margin to remain under pressure throughout 2013, as the company continues to invest in infrastructure and mobile strategy. Baidu’s R&D activities are focused towards improving its mobile search and its marketing efforts aim at increasing the adoption of its mobile portfolio.
While the steep decline in profitability seems discouraging, we believe it is necessary for Baidu to invest in these strategies on account of increasing competition in the search engine market and a trend towards mobile Internet being witnessed in China.
Increasing Competition In The Chinese Online Search Market
Rising competition in the Chinese Internet search engine market is another factor that has caused concerns among Baidu investors in the recent past. While Baidu enjoys a near monopoly in the Chinese online search market, the competition is heating up from Qihoo 360. Launched in August 2012, Qihoo has already captured over 10% market share. According to estimates by T.H. Capital, Qihoo’s market share rose from 13.9% at the end of Q1 2013 to 15.6% by June 25, 2013. The note by T.H. Capital also mentions that since most of the search queries for Qihoo are derived through its browser, Qihoo’s search market share could rise to the level of market share commanded by its browser, which stands at around 25%. .
Qihoo saw online advertising revenue of $63.4 million in Q1 2013, which represented an annual increase of 40%. We believe this represents a potent threat to Baidu’s dominance over the online search advertising market and this could have an adverse impact on its pricing power. We are keen to get new details regarding the strategies Baidu plans to adopt to tackle this rising threat.
Mobile Platform Development Represents The Top Priority For Baidu
With the Chinese internet market undergoing a transition towards increased mobile usage, this is contributing to certain problems for Baidu. Its low market share on mobile devices (37.5%), in contrast to desktops (more than 70%), and low mobile monetization problems are concerns which Baidu will have to address for its long-term growth. 
Baidu is aggressively taking steps to enhance its market share on mobile devices. Recently, the company signed an agreement to acquire 91 Wireless Websoft (a subsidiary of NetDragon) for $1.9 billion. 91 Wireless operates the two leading third-party app distribution platforms in China, and over 10 billion apps have been downloaded through these marketplaces.  We are encouraged by this acquisition since it strengthens Baidu’s play in the competitive Chinese Internet mobile market and can also result in new revenue stream for the company. As the developers on these app platforms will have to share their revenue with Baidu, this could contribute to increased mobile monetization.
We will update our price estimate for Baidu’s stock after the earnings release.Notes:
- China’s GDP Growth Slows to 7.5% in Second Quarter, The Wall Street Journal, July 14, 2013 [↩]
- Qihoo 360: TH Capital Sees Solid Quarter, Barron’s, July 9, 2013 [↩]
- China’s Baidu reports weaker profit growth in Q1, PCWorld, April 25, 2013 [↩]
- China’s Baidu to acquire local app stores for $1.9 billion, PCWorld, July 15, 2013 [↩]