While Qihoo 360 Technology Co Ltd (NYSE:QIHU) has taken some market share from Baidu, we think Baidu possesses a first-mover and network advantage that lends itself to maintaining market share. Google’s market share in the US is only now approaching 70%, and Baidu owns even stronger share in China. As long as Baidu’s market share remains above the 64%-66% range, we think it will continue to be the premier destination for search ads in China.
Mobile monetization for Baidu.com, Inc. (ADR) (NASDAQ:BIDU) has been a struggle—as it was initially for Google Inc (NASDAQ:GOOG) and Facebook Inc (NASDAQ:FB). Mobile advertising will be a huge growth engine in the Chinese internet space, and we believe its decision to open its platform up to international developers could create useful applicationsthat could lead to increased profitability. Essentially, we think Baidu will figure out how to best monetize mobile search.
Therefore, we are anticipating revenue will grow at a compounded annual growth rate (CAGR) of 23% over the next five years, and we believe earnings per share growth can also grow at a compounded rate of 18%. Our earnings expansion could prove conservative if the firm slows capital expenditure spending or improves operating margins.
We also believe there’s a possibility for the company to partner with Apple Inc. (NASDAQ:AAPL) in the mobile space. Although Apple may have its own designs, it is clear at this point that Apple and Google Inc (NASDAQ:GOOG) are no longer allies, so we think Apple would be enticed to join forces with a Google foe. Of course, Apple has yet to obtain market share in China comparable to what it has in the US, and Baidu already has a phone partnership with Lenovo that could make an Apple/Baidu relationship harder to consummate.
The China Discount
We can’t help but think some of the weakness can be attributed to a China discount. The amount of public equity market frauds is simply astounding, with established US companies like Caterpillar Inc. (NYSE:CAT) getting duped into paying high prices for companies with inflated/fake earnings. In addition to frauds, there is a great deal of valid skepticism surrounding the country’s economic growth. A lot of the value of an advertising vehicle like Baidu lies in consumption. If economic growth stagnates (or is stagnating), consumption, and thus advertising spending, could take a large hit. Reports of China’s “ghost cities” do not help its case.
All things considered, we at Valuentum think Baidu.com, Inc. (ADR) (NASDAQ:BIDU) looks like a wonderful business poised to capitalize on search advertising tailwinds. However, we find it difficult to get past the China Discount. Baidu has no history of accounting irregularities or frauds, but there have been complaints from CCTV regarding the validity of Baidu’s search results. These concerns aren’t much different from what we’ve heard about Google Inc (NASDAQ:GOOG) in the US, but it could lead to further market share losses if concerns resurface. Still, we’re wary of Chinese firms, so if we do decide to add shares to the portfolio of our Best Ideas Newsletter, it will not be a huge position.
RJ Towner owns shares of Apple. Valuentum holds shares of Apple and Google in the portfolio of its Best Ideas Newsletter. The Motley Fool recommends Apple, Baidu, and Google. The Motley Fool owns shares of Apple, Baidu, and Google.
