3 Things Baidu Can Do to Sustain Growth

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Xiaofan Zhang submits:

Baidu ( BIDU ) is the leader in the Chinese Internet search market. Its shares are now trading at 64x forward P/E, based on consensus 2010 EPS estimates. To sustain such a high valuation multiple, Baidu has to sustain its growth momentum. In this article, I discuss 3 things Baidu can do to live up to the capital market's expectations: growing its search queries, expanding its advertiser base, and improving its business model. Investors should monitor Baidu's efforts in these areas to determine whether the stock is worth holding.

  1. Grow Its Search Queries

Search queries are the most important growth driver for a search engine. Currently, search queries are growing spontaneously in China, supported by expanding Internet user base and the Chinese people's rapidly growing demand for information, products, and services, as the economy grows. This secular growth in search queries has ensured that Baidu's stock price has been in a long-term uptrend despite numerous short-tem setbacks since its IPO in 2005.

What can Baidu do to further boost search queries? According to industry experts, 30% of search queries in China are conducted on third-party websites that are not search engines. To seize this market opportunity, Baidu should further loosen its admission requirements for Baidu Union, so that more websites can become Union members that display Baidu search box to their visitors.

  1. Expand Its Advertiser Base

An active and diversified advertiser base is key to monetizing a search engine's traffic. As China's economy grows, lots of new industries are emerging. These new companies and products naturally need to do advertising to attract customers. Examples of such industries include online gaming, overseas travelling, 3G value-added services, professional sports, and home decorations.

I believe Baidu should identify promising segments of the Chinese economy, through researching its users' search query trends, and devote more sales efforts into pursuading companies in these industries to advertise on Baidu. Adding these new industries to its advertiser base enables Baidu to have more choices when it decides which ads it should display to its users.

As a result, Baidu's ads will be more relevant to users' search queries, and the click-through rates for its ads will increase.

In addition, as the number of advertisers grows, more Baidu search results pages will be covered by ads, and competition among advertisers will push up bidding prices in Baidu's system, which boosts price per click. Increases in click-through rates, ad coverage, and price per click will all lead to increased monetization for Baidu.

  1. Improve Its Business Model

A healthy business model should help a search engine to find the balance between the interests of users and advertisers when it monetizes its traffic. The goal here is to make the "Baidu Ecosystem" more fair and more compliant with standard, widely accepted principles, so that the ecosystem is more sustainable.

A sustainable ecosystem makes Baidu's growth outlook more certain, which will cause investors to assign a higher P/E ratio to Baidu's earnings per share, and ultimately helps Baidu's stock price. Baidu's recent transition to the Phoenix Nest system is a case in point: this change sacrificed some revenues in the short term because customers advertised more cautiously when they were still learning the new system.

However, I believe Baidu should firmly continue this transition: Phoenix Nest has given advertisers more tools and possibilities to reach their target customers and avoid reaching Internet users they are not targeting. This increases customers' return on investment, and causes these satisfied customers to place more ads through Baidu. Phoenix Nest is also an indirect long-term driver for Baidu's traffic growth because it improves Baidu's user experience by enabling users to better distinguish ads from search results.

Disclosure: No positions

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , International , Stocks

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