Baidu Pre-Earnings: Questions On Competition And Mobile Monetization Remain
Baidu ( BIDU ) is set to announce its Q4 earnings on Monday, February 4. It had a pretty good fourth quarter as total revenues increased to $995 million, growing almost 50% year-over-year. It also reported a 50% year-over-year increase in operating profit to $525 million.
Baidu's stock has been quite volatile during the fourth quarter, falling from $110 in early November to $90 in early December and rising again to $110 as of last Thursday. The volatility in the stock is a result of uncertainty surrounding its future. Questions remain around the company's mobile monetization strategy and rising competition, which have made investors doubtful about Baidu's business value. We will closely watch for any clarification regarding these elements as they will be key to Baidu's future growth.
As of early 2012, Baidu had approximately 35% market share in the Chinese mobile search market, substantially lower than its 80% share in PCs and desktops. This is troubling because as more users access the Internet via mobile devices, traffic growth to Baidu sites is likely to slow down. Nevertheless, Baidu has launched its own browser and OS to gain market share among mobile users. We, however, expect mobile monetization to remain low and would like to see a strategy for a solid product line that can leverage any increase in Chinese mobile ad spending going forward.
Search Engine Market Share
Over the last three years, Baidu has posted strong growth in EBITDA margins (from 45% in 2009 to 60% in 2011). This increase was helped in part by Google's troubles in the Chinese market, culminating in the firm's exit in 2011. Google's exit essentially strengthened Baidu's dominance in the Chinese search market though it could wane as new competitors enter the industry.
A major threat to Baidu's dominance is new search engine Qihoo which was launched in August 2012 and was almost an instant hit among users. If Qihoo's search engine is able to grab a chunk of market share from Baidu, it could lead to downside to our price estimate. That is why we are keen to know how Baidu's management tackles rising competition and the strategies that it would adopt to combat market share pressures.
We have maintained that online ad spending in the Chinese market could grow at a slower rate due to the worsening economic environment in the country. Our concerns were confirmed during the fourth quarter as Chinese Internet company Tencent warned that online ad spending growth is slowing. This slowdown in growth combined with new competition that Baidu is facing could impact the company's margins for two reasons.
First, the pricing power that Baidu enjoyed due to its near monopoly is likely to hinder the company's ability to pass on cost increases to advertisers. If it is unable to charge the same premium for specific search keywords, we will see a decrease in margins. Second, we could see the Chinese Internet landscape become more like Silicon Valley in terms of competition for best engineers and, with more competition for talent, Baidu will likely have to push salaries higher to retain employees. Therefore, margins will be an important factor to watch for this quarter as a fall in margins to around 50% would cause 10% downside to our price estimate.
We currently have a $125 price estimate for Baidu , which is approximately 15% above the current market price.