Key Trends Impacting Baidu’s $143 Valuation
Quick Take
- Baidu is China’s largest search engine with around 80% share of the search market in the country.
- Since 2008, the company’s revenue has grown by more than 60% annually to $3.5 billion in 2012.
- Baidu’s search market share has benefited from Google’s exit in 2011. We estimate Baidu’s market share to decline in the future due to rising competition from other search providers and the company’s less dominating presence on mobile.
- We also estimate that profitability will remain under pressure on account of investments in the mobile platform.
Baidu (NASDAQ:BIDU) is the leading internet search provider in China. In addition to helping users find information online, the company provides an effective platform for businesses to reach potential customers. Baidu’s revenues have grown annually by about 65% since 2008, topping $3.5 billion in 2012. The company derives about 60% of its revenues from search advertising, the remainder coming from display advertising and partnerships.
While Baidu dominates China’s search market with over 80% share, we believe this share will decline in the future due to heightened competitive activity. The company is facing increased competition from other leading internet search providers as well as newer entrants. Additionally, Baidu’s share in the booming mobile search market is nearly half of its share in desktops. Though the company has stepped-up efforts to enhance its mobile presence, it will struggle to significantly increase its share in mobile, in our view.
Our price estimate of $143 for Baidu’s stock marks our valuation at a discount of over 15% to the current market price. In this article we provide a snapshot of how Baidu generates revenues and the key trends that impact its business.
See our complete analysis of Baidu here
Who are Baidu’s customers? How does the company make money?
Baidu provides online marketing services to a diverse customer base, which includes small and medium enterprises, large domestic companies, as well as subsidiaries of multinational companies in China. In 2012, the company had 596,000 active online marketing customers across industries such as financial services, technology services, software, online games, transportation, tourism and ticketing. [1]
Online marketing services include P4P (pay-for-performance) services and other performance-based online marketing services. While P4P customers pay when users click on ads placed on Baidu search result pages or Baidu Union members’ site, customers availing other services pay based on performance criteria such as the number of telephone calls brought to the customers, the successful booking of air tickets or hotel rooms, or the number of minimum click-throughs. The company also offers time-based online advertising services under which customers pay according to the duration of the advertisement placed on Baidu’s websites.
What are the key trends impacting Baidu’s stock price?
1. Rising competition is a threat to search advertising market share
Baidu’s share of the Chinese search market has benefited in part due to Google’s troubles in the market, which culminated in the firm’s exit from China in 2011. Baidu’s market share increased from 67% in 2008 to 82% in 2012. However, competition in the search market has again increased due to the entry of Qihoo 360. Launched in August 2012, Qihoo has already gained more than 15% share of the market. According to T.H. Capital, Qihoo’s market share increased from 13.9% at the end of March 2013 to 15.6% by the end of June 2013. [2]
Baidu also faces competition from other leading Chinese internet companies such as Tencent and Alibaba. In September 2013, Tencent expanded its presence in the search engine market by purchasing 36.5% stake in Sogou (a search engine by Sohu.com) for $448 million. [3] We believe that intensifying competition in the search engine market will negatively impact Baidu’s market share in the future.
2. Lower market share and monetization levels in the mobile search market
The Chinese internet market is in the midst of a transition phase, with an increasing number of users accessing the web with the mobile devices. Baidu has approximately 37% market share in the Chinese mobile search market, which is much lower than its share in PCs and desktops. Monetization levels in mobile search are low on account of the smaller screen size. Even though we note that Baidu has improved its mobile monetization levels in the last few quarters with increased focus on enhancing its mobile platform, we believe the fragmented nature of the market will make it difficult for the company to grow its market share rapidly in the future.
3. Declining profitability due to investments in mobile platform
Baidu is facing pressure on its profitability due to increased investments in mobile strategy and infrastructure. Mobile computing is a key strategic area for Baidu, since people in China are shifting from personal computers to mobile devices to access the web. The company has taken some good steps in this space, such as launching its own mobile OS and browser.
Increased promotional activities related to the distribution of mobile products led to a 72% rise in marketing and promotion expenses for Baidu in 2012. Consequently, the company’s EBITDA (earnings before interest, taxes, depreciation and amortization) margin declined to 55% from 59% a year ago. We expect Baidu to spend more on mobile related SG&A and R&D in the short-term which will continue to put pressure on margins.
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Notes:- Baidu Annual Report, Baidu Website, 2012 [↩]
- Qihoo 360: TH Capital Sees Solid Quarter, Barron’s, July 2013 [↩]
- China’s Tencent expands search engine presence with Sogou deal, PCWorld, Sep 2013 [↩]