One possibility is, the company expands its business into other industries, diversifying its revenue streams. The second is, the company runs into problems and begins to lose market share to its competition. These are the two possibilities facing Baidu.com, Inc. (NASDAQ:BIDU). Either the company expands and continues to grow or it becomes just another Internet company.
Searching for growth
The investing premise behind Baidu used to be very simple. Baidu was and is the dominant search company in the Chinese market. In theory, Baidu.com, Inc. (NASDAQ:BIDU) should have the same opportunities as Google Inc (NASDAQ:GOOG). If investors are willing to pay 20 times projected earnings for Google’s expected 15% earnings growth, then why wouldn’t investors pay an equal premium for faster growth at Baidu?
Not long ago, analysts were calling for 40% EPS growth from Baidu over the next few years. The stock was valued at about 30 to 40 times projected earnings, and the comparison between Baidu and Google made sense, while other competitors like Sohu.com Inc (NASDAQ:SOHU), were only expected to grow earnings by 15%. At the time, Baidu.com, Inc. (NASDAQ:BIDU) seemed unstoppable and the stock rose like a rocket. Some thought that if Google Inc (NASDAQ:GOOG) could grow earnings by 15% in a saturated United States market, Baidu should easily be able to grow at a faster clip in a Chinese market with about one-third the internet penetration.
What Happened?
As Baidu’s market position seemed unassailable, an upstart anti-virus company Qihoo 360 Technology Co Ltd (NYSE:QIHU) decided that it didn’t like the status quo. Qihoo began offering search results to its anti-virus users, and Baidu seemed to be caught off guard.
Today, Baidu.com, Inc. (NASDAQ:BIDU) is spending money in hopes of not only countering the Qihoo threat, but its also trying to take over the mobile game in China. If mobile is the future of Baidu’s growth, China’s huge population and well-connected mobile user base should serve the company’s aspirations well. The real question investors must ask is, what must Baidu do in order to regain its lost momentum?
4 key metrics
There are a few things investors can look for in Baidu’s next earnings release to determine if the company will regain its momentum. First, the hallmark of Baidu.com, Inc. (NASDAQ:BIDU)’s growth story has been strong revenue growth. In its last earnings report, the company reported a 40% jump in revenue. Even if sales growth were to slow, it seems reasonable to expect that the company can grow earnings by around 20% per year. If Baidu is to maintain its growth trajectory, it’s absolutely critical the company continues to grow its top line.
A second item that investors should be on the lookout for is, continued strength in both online marketing customers and revenue per customer. Baidu reported an increase of 27.7% in active online marketing customers and revenue per marketing customer increased by 9% last quarter. Any significant slowdown in either of these numbers would spell trouble.
The third issue, was a painfully obvious problem for Baidu.com, Inc. (NASDAQ:BIDU) last quarter. The company’s spending in the areas of SG&A and R&D expenses seemed a bit out of control. If we compare Baidu’s SG&A expenditures as a percentage of revenue, the numbers don’t look that bad. The company spent 14.21% of revenue on this line item.
Compared to Qihoo 360 Technology Co Ltd (NYSE:QIHU)’s expenditure of 28.1%, Google’s expense of 19.91%, and Sohu.com Inc (NASDAQ:SOHU)’s 27.17%, Baidu.com, Inc. (NASDAQ:BIDU) looks pretty conservative. The problem is, this one line item increased by 77% on a year-over-year basis, and the company attributed this to an, “increase in promotional expenses.” With SG&A expenses nearly doubling the rate of revenue growth, earnings took a hit.
In a similar manner, the company’s R&D expenses were problematic last quarter. Baidu spent 13.58% of revenue on R&D. By comparison, each of their peers spent more, with between 13% and as much as 47% of revenue on R&D. The issue was not the current percentage of revenue, as much as the rate of increase, as R&D expenses jumped by over 82% on a year-over-year basis.
Last but not least, investors seem to be overreacting to the company’s higher traffic acquisition costs, as Baidu still only pays about 10% of advertising revenue for this item. Though Google Inc (NASDAQ:GOOG) is far more established, the company regularly pays between 25% to 26% on traffic acquisition. The difference between Baidu.com, Inc. (NASDAQ:BIDU) and Google is, Google Inc (NASDAQ:GOOG) has seen its traffic acquisition costs level out over the last few years, whereas Baidu has reported a relatively significant increase the last few quarters.
Foolish final words
Within the next few weeks, investors should find out if the Baidu growth story will continue. The investments in mobile make a lot of sense for the company’s future growth, but only if the company can maintain a reasonable level of expenditures.
If management spends too much money too quickly, the company’s earnings could suffer, and Baidu.com, Inc. (NASDAQ:BIDU)’s growth story could change dramatically. Investors seem to be giving the company the benefit of the doubt, but this next earnings release could be a make it or break it moment for the stock.
The article A Make it or Break it Quarter originally appeared on Fool.com and is written by Chad Henage.
Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Baidu, Google, and Sohu.com Inc (NASDAQ:SOHU). The Motley Fool owns shares of Baidu.com, Inc. (NASDAQ:BIDU) and Google Inc (NASDAQ:GOOG). Chad is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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