Baidu (NASDAQ:BIDU) is the largest Internet search provider in China with 73% share of the search traffic. Until mid-2013, there were concerns surrounding the company’s mobile monetization capabilities and high dependence on the search business. However, Baidu grew organically as well as inorganically in the last few months to overcome these problems. It worked towards building a better mobile ecosystem and diversifying into newer businesses. This helped it accelerate top-line ($1.6 billion) growth to 50% in Q4 2013 from 42% in Q3. Baidu expects further acceleration in top-line in Q1 2014. The company has provided guidance for revenue growth in the range of approximately 55% to 60%. 
While increasing monetization on Baidu’s mobile platform was one of the major drivers behind the solid revenue growth in Q4, aggressive investments in building mobile products weighed on the company’s profitability. Operating profits stood at $453 million, a 3.8% decline over the year-ago period. During the earnings call, Baidu said that it has more new products in its pipeline for mobile and therefore, it will continue to invest heavily this year on driving installations and usage of these mobile products. The expenditure will occur mostly on sales and marketing, infrastructure, content and traffic acquisition. The company does not expect to see absolute profit growth in 2014 due to these investments.  However, EBITDA could grow due to amortization of certain intangibles resulting from the company’s recent acquisitions of Nuomi, PPS and 91 Wireless.
Although we expect margins to remain depressed over the years, 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.  Further, the company needs to defend its share from emerging competitors such as Qihoo and Tencent.
Mobile Monetization Improving Robustly
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, 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. 91 Wireless is the largest third-party app distribution company in China with over 40% market share.
Baidu’s search app witnessed over 400 million activated users in Q4 compared to 330 million users in the prior quarter. The company also saw an improvement in mobile advertising rates (cost per click), which reached 60% of PC advertising rates from 55% in Q3. Baidu expects to see further convergence in mobile and PC monetization as mobile traffic overtakes PC traffic in 2014.
Owing to the increase in mobile traffic and monetization, the contribution of mobile to Baidu’s total revenues doubled in Q4 from 10% in Q2.  We expect mobile revenues to continue growing strongly. However, we also note the possibility that Baidu could find it difficult to increase its mobile market share significantly in the near future because the market is fragmented with the presence of various players such as Qihoo, Tencent and Easou.
Diversification Seems To Be A Good Long-Term Bet
Baidu’s business portfolio is more concentrated on search advertising, which accounts for over 60% of its revenues and 50% of its value, according to our estimates. To reduce its dependence on search in the wake of rising competition, Baidu acquired Nuomi ($160 million for 59% stake) and PPS ($370 million) last year. It bought out the remaining stake in Nuomi from Renren in January this year.
Baidu is focused on providing a comprehensive experience to users from answering search queries to delivering services such as group buying and taxi and hotel bookings. Nuomi is increasingly becoming an important part of Baidu’s location based service offerings through Baidu Maps. According to Dataotuan, Nuomi accounts for about 10% of the revenues of the local deals market in China. It has been facing huge losses since inception due to intense competition. However, the sector is seeing a consolidation. We expect Nuomi to become profitable after the industry is left with only a few players. Group buying transactions on Baidu Maps increased 60% sequentially in the fourth quarter.
The acquisition of PPS, an online video service, has strengthened Baidu’s position in the online video market. Baidu acquired PPS last year in May and merged it with its online mobile video platform, iQiyi, to become the largest online video platform in China.  According to a report by McKinsey, about 570 million Internet users in China watched online video content in 2013. The figure is expected to surpass the 700 million mark by 2015. 
Although Baidu is diversifying into newer businesses, we think that search is its core competency. The company needs to defend its search market share from Qihoo to maintain its growth trajectory. Launched in August 2012, Qihoo has already gained more than 15% share of the market.  Baidu also faces competition from other leading Chinese internet companies such as Tencent and Alibaba.
We are in the process of updating our $143 price estimate for Baidu, based on the fourth quarter and full year earnings results.Notes:
- Baidu’s CEO Discusses Q4 2013 Results – Earnings Call Transcript, Seeking Alpha, February 2014 [↩] [↩] [↩]
- 2012 China Mobile Search Market Report, iResearch, September 2012 [↩]
- Why Baidu Acquired Renren’s Group-Buying Site, The Motley Fool, January 28, 2014 [↩]
- Succeeding in China’s online video market, McKinsey & Company, July 2011 [↩]
- Qihoo 360: TH Capital Sees Solid Quarter, Barron’s, July 2013 [↩]