Bulls Run With Baidu

Jim Trippon  |

Chinese internet search giant Baidu (BIDU) reported sensational third quarter earnings recently. The internet and search company, whose name is taken from a poem written during the Song Dynasty and means “hundreds of times,” which represents what Baidu calls “the persistent search for the ideal,” continues to produce high growth quarters. Also known as “the Chinese Google (GOOG),” Baidu, which as of mid-2011 counted the world’s largest internet user population of 477 million people, saw its stock price jump more than 6% on the earnings report as it also gave strong guidance for its fourth quarter. Its torrid revenue and earnings growth set the pace as other Chinese internet stocks also moved higher. Baidu earned $0.86 a share on revenue of $654.7 million. Revenue increased 85.1% year over year in the third quarter, while earnings per ADR were up nearly 80%.

Baidu One Year Chart vs. Google & S & P 500

Source: Yahoo! Finance

Baidu earned $295 million, $0.86 cents a share on a reported basis and $0.84 on an adjusted basis per ADR, compared to $0.47 per ADR in last year’s third quarter. Revenue of $654.7 million compared to revenue of $355 million in the same quarter a year ago. Baidu continues its rapid growth and this quarter was no exception. An increase in user traffic and customer spending were the drivers for this quarter’s growth. The launch of a personalized homepage for users, customizable as their portal not just for search but for the internet was launched in the quarter. The integration of Qunar, an internet travel search engine acquired, contributed to results, and Baidu further invested in its online video service provider, Qiyi, to support Qiyi’s growth. Key traffic acquisitions costs, or TAC, fell by 8% year over year, to $54.2 million, and Baidu increased its online marketing customers by 11.8% to 304,000. Its outlook for the fourth quarter put expected revenue in the $691.4 million to $711 million range, which would represent an increase of 79% to 85%.

Since Google closed its internet search engine on mainland China in March, 2010 due China’s government censorship rules, Baidu’s share of the search market has risen to 76 percent from 64 percent. Google, which still has a presence in Greater China with a search engine through Hong Kong, has seen its share of the search market fall to 19 percent from 31 percent. While Google is still many times larger than Baidu, with its latest quarterly earnings of $2.7 billion on $9.7 billion revenue, its effective exit from China has left the rapidly growing China market to Baidu and other Chinese internet companies.Baidu continues to respond to the opportunity with its nearly exponential growth.

Baidu ADRs have traded between $94.33 and $165.96 in the last 52-weeks, and recently closed at $144.62. Shares had traded as low as $105.16 on October 3rd, so investors have certainly noticed the stock has made an impressive run in the month both prior to its earnings and after the announcement. This is a roughly 40% surge in four trading weeks. What’s more impressive is that Baidu has had to overcome much of the ongoing negative publicity China ADRs have been getting. Much of the financial news has been filled with gloomy predictions on China’s growth, and while its economy has slowed some, it’s not as if the Chinese economy has somehow fallen off a cliff or is in danger of doing so.

Three Month Chart of Baidu   Source: Yahoo! Finance

Internet stocks, led by Baidu, have also been hit by concerns over their variable interest entity or VIE structure, an esoteric term that stands for a practice that has streamlined many Chinese entrepreneurial businesses, those that began as private businesses which have been able to raise capital and get listed in financial markets outside of China. Baidu, like many VIEs, is listed on the Nasdaq but is not listed on the mainland China exchanges, and thus is able to raise capital from foreign investors, something which has been a process much more scrutinized and regulated for the state owned enterprises, or SOEs, by the Chinese government.

All well and good, as this was by design by the Chinese government, at least to allow for many companies to utilize the VIE structure to streamline things and be able to move more rapidly. Unfortunately, when many of the companies that utilized the VIE were found to be steeped in accounting fraud and corruption, some of which were eventually delisted on the Nasdaq, fears were that the Chinese government would shut down all the VIEs.This was simply rumor, as there was never any indication that the PRC regulators were even thinking of shuttering or even cracking down somehow on Baidu and other booming Chinese internet stocks such as Sohu (SOHU), Sina (SINA) or social networking stock Renren (RENN). The imminent demise of Baidu was greatly exaggerated, but not until its stock price took a hit.

With Google’s retreat, there has been a further open door for Baidu to completely embed itself as the dominant search company in China. There are potentially millions more users to be mined. One thing Baidu might need to do, though, is expand its model into social networking, as that is the internet portal model of the very near future. Robin Li did meet with Facebook founder Mark Zuckerberg when Zuckerberg toured China, so Baidu’s management is well aware of social media. As for the stock price, it’s straight up run in October gives pause; even growth investors should wait for a retreat in price, as the PE of 65, even though it’s well matched to the earnings growth rate of nearly 80%, allows no meaningful margin for error. Investors should wait for a substantial pullback before buying.
For further information on the Chinese markets, you may visit www.chinastockdigest.com or join us at www.globalprofitsalert.com for our daily market commentary. I will look forward to bringing my exclusive insight to you next week.

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