Baidu’s Top-Line Accelerates On Strong Growth In Core Search Business

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Baidu (NASDAQ:BIDU) is the largest Internet search provider in China with 73% share of the search traffic. The company marked a solid start to this fiscal year with 59% growth in Q1 revenues, topping $1.5 billion on strong growth in the core search business. Until mid-2013, there were concerns surrounding the company’s mobile monetization capabilities. However, Baidu grew organically as well as inorganically to overcome these problems. It worked towards building a better mobile ecosystem by integrating more services and increasing its app distribution strength. This helped it boost all metrics including mobile traffic as a percentage of total traffic and cost-per-click. Baidu expects mobile traffic to surpass PC traffic sometime this year. [1]

Investments in enhancing its mobile capabilities and supporting growth at its newly acquired subsidiaries—91 Wireless, PPS and Nuomi—have weighed on Baidu’s profits in the last few quarters. EBITDA margins (in percentages) have declined from the 50’s to the 40,s and the company does not expect absolute profit growth this year. Baidu has more new products in its pipeline for mobile and will therefore continue to invest heavily on driving installations and usage of these mobile products.

We are in the process of updating our $175 price estimate for Baidu’s stock based on the recently announced results.

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See our complete analysis of Baidu here

Growth In Customer Base to Reaccelerate From This Quarter

The number of customers actively availing online marketing services from Baidu has sequentially declined in the last few quarters. Baidu had about 446,000 active online marketing customers in Q1, lower compared to 464,000 in the third quarter of 2013. The drop was the result of the company’s +V verified account program that was rolled out across the majority of customers. The program aims to improve the quality of customers by verifying their legitimacy. Only verified businesses can do business with 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 from next quarter as the +V program has now been fully rolled out. Additionally, the company’s new idea of allowing advertisers to bid at city level rather than province level will bring in more marketing customers.

Recently Acquired Subsidiaries Are Being Smoothly Integrated

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. Group buying, taxi hailing, movie ticket purchasing and hotel booking transactions on Baidu Maps increased by 80% sequentially in the first quarter. [1]

Nuomi is leveraging Baidu’s web traffic resources and extensive sales force infrastructure to scale up its operations. According to Dataotuan, the group buying site accounts for about 10% of 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.

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. [2] We think that Baidu can win the market with its focus on a strong quality of service, brand recognition and user traffic.

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.

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Notes:
  1. Baidu’s CEO Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, April 25, 2014 [] [] []
  2. China Online Video Market Snapshot in Q4 2013, China Internet Watch, March 5, 2014 []