Mobile Will Boost Baidu’s Top Line This Quarter But Will Also Weigh On Profitability

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Baidu (NASDAQ:BIDU) is slated to report its Q4 2013 results on February 6 (tentative). The leading Chinese language online search provider earned $1.45 billion in revenues in the third quarter, registering revenue growth of 42.3% year on year. While increasing monetization on the company’s mobile platform was one of the major drivers behind the solid revenue growth, aggressive investments in building the mobile products weighed on the company’s profitability. Operating margin slipped to 37.5% in Q3 2013 from 52.7% in Q3 2012, as mobile drove SG&A and R&D expenses up by 115% and 77% year-over-year respectively. Consolidation of recent investments in the online video vertical (iQiyi) and increased infrastructure capacity further elevated the operating costs. [1]


While we believe that operating margins will remain depressed in Q4, we think that Baidu is heading in the right direction by investing in these strategies. That’s because the revenues of China’s mobile search market are forecast to grow at a compounded rate of approximately 40% to reach $560 million by 2015. [2] Further, the company needs to defend its share from emerging competitors such as Qihoo and Tencent.

We will update our $143 price estimate for Baidu’s stock after the upcoming results are announced.

Customer Base Will Continue To Expand Annually

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During the third quarter, Baidu had about 464,000 active online marketing customers, up 19% compared to the year-ago period but down by 1% quarter-on-quarter. The sequential drop was the result of its +V verified account program that was rolled out across the majority of customers. The program aims to improve the quality of customer by verifying their legitimacy.  Verified businesses receive a blue +V logo in sponsored links and enhanced options to advertise on Baidu. A better quality customer base helps Baidu to increase ARPU (average revenue per user). [1]

We believe that Baidu’s customer base will get back its sequential momentum in the next couple of quarters since the +V initiative has already reached the majority of customers. This should allay some of the fears related to rising competition from Qihoo. Launched in August 2012, Qihoo has already gained more than 15% share of the search market. [3] Its management aims to increase its share to 40% by 2015. [4] 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. [5]

Mobile Monetization Is Improving But The Fragmented Market Limits Near-Term Scope

To tighten its grip over mobile search, Baidu invested in various parts of the mobile ecosystem last year. It introduced an integrated PC and mobile bidding system in the second quarter, which contributed to increased advertising on the mobile platform. A nationwide search engine marketing campaign with heightened focus on mobile was also undertaken by the company to bolster the adoption of its mobile products. Additionally, it acquired 91 Wireless Websoft—China’s largest third-party app distribution company—in a $1.9 billion deal to strengthen its app distribution capabilities. [6]

The mobile strategy yielded positive results for Baidu, helping the company to earn more than 10% of its total revenue from mobile in Q2, the first time ever in any quarter. It also helped the company to grow the installed base of its mobile search app by 50% sequentially to more than 330 million, at the end of Q3. [1]

Baidu has dominated the desktop search market since 2010 with over 70% share. However, its mobile search market share is about half of its desktop share. Although Baidu’s mobile monetization is improving, we believe the company will find it difficult to raise its share in mobile significantly in the near future as the market is fragmented with the presence of various players such as Tencent and Easou.

See our complete analysis of Baidu here

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Notes:
  1. Baidu’s CEO Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 2013 [] [] []
  2. 2012 China Mobile Search Market Report, iResearch, September 2012 []
  3. Qihoo 360: TH Capital Sees Solid Quarter, Barron’s, July 2013 []
  4. China’s Qihoo takes aim at Baidu with aggressive goal to capture 10% of local search market per year, TheNextWeb, February 2013 []
  5. China’s Tencent expands search engine presence with Sogou deal, PCWorld, September 2013 []
  6. Baidu Pays $1.9 Billion in Biggest Takeover to Gain Mobile Share, Bloomberg, July 2013 []