Baidu (NASDAQ:BIDU), the largest Internet search provider in China with 73% share of the search traffic, is slated to release its results for the first quarter of FY2014 Thursday, April 24. 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 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 growth in Q1 2014. The company has provided guidance for revenue growth in the range of 55% to 60%. 
Baidu’s stock price nearly doubled in the back half of 2013 to $182. It has since fallen to about $160 in a down market. We have a price estimate of $175 for Baidu. We will update our model after the upcoming results.
Investments In Mobile To Improve Monetization But Also Weigh On Margins
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 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. 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. 
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 4% decline over the year-ago period. Baidu 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. We do 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 year, 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.
Acquisition Of Nuomi Has Enhanced Location Based Service Offerings
Baidu acquired a 59% stake in Nuomi last year for $160 million. It bought out the remaining stake from Renren in January this year. Nuomi is increasingly becoming an important part of Baidu’s location based service offerings through Baidu Maps because 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. Group buying transactions on Baidu Maps increased 60% sequentially in the fourth quarter. 
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.
Baidu Now Owns The Largest Online Video Platform In China
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 with 358 million monthly users. We think that Baidu’s strategy for online video is a good long term bet. According to iResearch, the online video market in China will grow at a compounded rate of over 30% from $12.8 billion in 2013 to $36.6 billion by 2017. 
Competition From Qihoo Poses The Biggest Threat To Baidu
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 24% share of the search market as measured by page views. Its management is targeting a share of 35% for 2014 and 40% for 2015. Going forward, we expect Baidu to concede some of its share to Qihoo.Notes: