Baidu (NASDAQ:BIDU) is the largest Chinese language Internet search provider in the world. Until mid-2013, there were concerns surrounding its mobile monetization capabilities and high dependence on the search business. However, the company grew organically as well as inorganically to overcome these problems, which provided a strong boost to its stock. Baidu’s stock price nearly doubled in the back half of 2013 to $182. It has since fallen to about $151 in a down market. In this article, we closely analyze the factors that led to this sharp up-move. Our price estimate of $143 for Baidu is at a discount of about 10% to this market price, as we believe that there are certain challenges that Baidu still needs to overcome.
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Monetization On Mobile Is Improving But The Fragmented Market Limits Near-Term Scope
While Baidu has dominated the desktop search market in China since 2010 with over 70% share, the company is not as formidable in mobile search. Its market share in mobile search stood at 35% in 2012. Further, mobile accounted for less than one-tenth of the company’s revenue. At that time, China’s mobile search market revenues were forecast to grow at a compounded rate of approximately 40% to reach $560 million by 2015.  Therefore, Baidu’s low monetization on mobile was emerging as a hindrance to the company’s future growth.
Last year, Baidu invested in various parts of the mobile ecosystem to tighten its grip over mobile search. 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 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.  Although these initiatives took a toll on Baidu’s EBITDA margins, the company was able to lift its market share in mobile search to about 38% by mid-2013. The contribution of mobile to total company revenues also increased to 10% in Q2, the first time ever in any quarter.
While Baidu is aggressively taking steps to enhance its mobile product portfolio, the mobile platform will continue to suffer from low monetization problems, in our view. Monetization levels are lower on mobile compared to desktops due to the smaller screen size. We believe the company will find it difficult to raise its share in mobile search significantly in the near future as the market is fragmented with presence of various players such as Tencent and Easou.
Diversification Into Group-Buying And Online Video Is Beneficial But Search Market Share Must Be Protected From Competition
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. The company commands over 80% share of the Chinese search market. However, rising competition from a new player Qihoo 360 is threatening the company’s leadership position in the industry. To decrease its dependence on search advertising in the wake of increasing competition from Qihoo, Baidu acquired Nuomi ($160 million for 59% stake) and PSS ($370 million) last year to diversify its business. It bought out the remaining stake in Nuomi from Renren in January this year.
According to Datatuan, Nuomi controls around 5.9% of the group-buying sector in China.   The deals website has been facing huge losses since inception due to intense competition. However, the sector is seeing a consolidation. The number of group buying companies in China fell from 5,000 in August 2011 to 3,000 in October 2012, and is expected to fall further.  We expect Nuomi to become profitable after the industry is left with only a few players. With Nuomi now having access to Baidu’s resources, the group-buying site could expand into several Chinese cities to boost its market share.
The acquisition of PSS, an online video service commonly used in PCs, has strengthened Baidu’s position in the online video market. Baidu acquired PSS 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 breach 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. 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.  We believe that intensifying competition in the search engine market will negatively impact Baidu’s market share in the future.Notes:
- China Mobile Search Market Report, iResearch, 2012 [↩]
- Baidu Pays $1.9 Billion in Biggest Takeover to Gain Mobile Share, Bloomberg, July 16, 2013 [↩]
- China’s Baidu buys majority stake in group buying site Nuomi, PCWorld, August 23, 2013 [↩]
- 2013 Q1 – China Daily Deal Market Report – A Stable Start, Dataotuan, May 16, 2013 [↩]
- Group-Buying Sees Revival on Mobile Devices, Alipay Says, CaixinOnline, January 2013 [↩]
- 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 [↩]
- China’s Tencent expands search engine presence with Sogou deal, PCWorld, Sep 2013 [↩]