Market Share And Broader Chinese Economy Risks Could Impact Baidu

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Baidu (NASDAQ:BIDU) has lost favor among Wall Street participants in the recent past — the stock has fallen by around 30% over the past three months, owing to various concerns facing both the company as well as the broader Chinese economy. While our $216 price estimate represents a bullish outlook, we believe there are certain pessimistic and downside scenarios that could swing the stock considerably over the next few years. Specifically, the increasing risks to Baidu, pertaining to macro-economic challenges in the Chinese economy and the company’s market share in the online search engine market, present certain bear case events that could influence stock price changes for the worse in the coming years, in our view.

See our complete analysis of Baidu here

Baidu’s Market Share (By Revenue) In The Chinese Search Engine Market Falls To 60% By 2018 (-15%)

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Threat to its dominant market share in the Chinese search engine market is one of the most potent risks for Baidu in the coming future. Baidu’s market share on desktop search has slipped quite significantly over the past few years — according to DAO Insights (a social insights company), the market share decreased from 80.4% in August 2012 to 54.0% in August 2014. [1] At the same time, the market share for Qihoo 360 and Sogou has increased considerably. The positive aspect for Baidu has been its ability to retain dominance over the mobile search market, with around 80% overall market share by revenue (as of Q2 2015). [2] But with Qihoo and Sogou having aggressive plans to step their mobile market share and monetization, we believe Baidu is going to face challenges in the coming years.

In our valuation model, we estimate Baidu’s search revenues to surpass $19 billion by 2018. Total revenue in the Chinese search engine market is forecast to reach 167.6 billion yuan ($26.1 billion) in 2018, according to iResearch (a research company which focuses on the Chinese Internet sector). [3] This pegs our market share estimate (by revenue) for Baidu at around 72.5% in 2018. However, we believe another scenario is plausible wherein Baidu’s market share (by revenue) could drop even further to 60% by 2018. This scenario represents 10-15% downside to our current price estimate. We believe this scenario could take place due to the following factors:   1) Qihoo and Sogou are able to repeat their performance in the mobile search engine market; 2) price cutting by Qihoo and Sogou could lead to a loss of revenue for Baidu; and, 3) recent weakness in the Chinese economy could influence smaller players to gravitate to other cost effective online marketing channels.

Current Macro-Economic Risks In China Spill Over To The Internet Sector (-20%):

The recent stock market plunge in China has brought to light the broader risks inherent in the world’s second largest economy. While China’s economy has been driven by exports and more recently by investment (post the 2008 recession), it needs re-balancing to gain a larger share of its GDP from consumption. But this will not be easy for the Chinese government, given that its recent moves to arrest the fall in the stock market could well be counter-productive to its long-term goal of reforming the economy. Additionally, the Chinese economy is also beset with other problems, such as a real estate bubble and availability of excess credit.  This further adds complexities in China’s response to current economic concerns.

Though iResearch forecasts revenue in the Chinese search engine market to grow at a compound annual rate of around 30% between 2014 to 2018, we believe these forecasts represent a more optimistic view of the country’s economy. In the event, the Chinese economy slows down considerably, it will also impact the Internet sector, in our view. Under a scenario, in which the macro-economic slowdown causes the Chinese search engine market to rise at 20% CAGR (instead of the original 29% estimate), it will lead to 20% downside to our price estimate to $175. We believe this scenario is plausible, since:   1) the current crisis could impact consumption levels in the country;  2) the Chinese economy already suffers from a debt overhang, which would make future policy changes more difficult; and, 3) the economic slowdown will also compound political risks, making the transition process more complex to execute.

Our $216 price estimate for Baidu’s stock, represents more than 40% upside to the current market price.

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Notes:
  1. Chinese Search Engine Landscape – Baidu Losing to 360 and Sogou, DAO Insights, January 28, 2015 []
  2. China’s Search Engine Market Overview in Q2 2015, China Internet Watch, August 4, 2015 []
  3. Revenues of China Search Engine Companies Surpass 60 Bn Yuan in 2014, iResearch, March 6, 2015 []