In early 2014, Baidu Inc (ADR)‘s (NASDAQ:BIDU) American Depositary Shares traded above $240 per share. BIDU stock has settled down to $166, or 30% from its high from over two years ago.
The firm calls China home, which happens to be the fastest-growing market for internet-based search and advertising.
Baidu is the undisputed leader in this market, but has come up against a few challenges in the near-term. Right now, investors are trying to discern if dip in BIDU stock represents a buying opportunity.
The Baidu Advantage
BIDU stock dominates the Chinese market for online and mobile internet search. It boasts a market share of around 80% in China and billions in cash in the bank, demonstrating just how profitable it has been for shareholders. In comparison, Alphabet Inc’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google search franchise dominates the U.S. market, but only has about 64% market share.
Google left China back in 2010 following concerns about hacks on its Gmail email service. It is rumored to be contemplating a comeback in China, but will likely be little threat to BIDU stock for some time. However, the company does have plenty of competition right in its back yard.
Baidu generates most of its revenue from online marketing. China represents the largest online market in the world, and although growth isn’t as robust as it used to be, it is growing to be among the fastest in the world. BIDU should be the biggest beneficiary of this market, and, like Google, it has successfully migrated from consumers shifting their use from computers to mobile phones and related devices. This business is also fantastically profitable.
Challenges for BIDU Stock
In Baidu’s latest annual filing with the Securities and Exchange Commission, it discusses “questionable paid search listings” and its goal to remove them to “ensure the quality and reliability of [its] search results.”
Tragically, back in April, a Chinese student with a rare form of cancer died after attempting an experimental therapy he found from a search result from BIDU.
Authorities in China have launched an investigation and Baidu has also committed itself to reducing the possibility of allowing products or services that can hurt its customers. The matter has certainly caused some uncertainty in the near-term. BIDU has reduced its sales guidance for the year, and profits are also expected to suffer for a little while.
The unfortunate medical matter is significant, as this type of advertising accounts for an estimated 20% to 30% of its advertising revenue. Chinese authorities have said that, Baidu must change its advertising practices, though further details have yet to be made.
The near-term challenges were evident when BIDU reported what it described as a tough second quarter. Sales growth was still respectable at 10.2% and total sales rose to just less than $3 billion. Mobile-related revenue (from mobile phones, tablets) jumped to 62% of quarterly sales, up from 50% just a year ago.
Monthly active users increased a respectable 6% to 667 million. This falls below Google Chrome’s recent MAU total of 1 billion, but the Chinese market has much greater growth potential. From a top-line perspective, most companies would be envious to post double-digit growth and consider it a tough quarter.
However, the profit picture was far less healthy for BIDU stock. Operating profit fell 17.4% to $431.3 million and net income plummeted 34.1% to $363.2 million. This worked out to $1.22 per ADS (the shares that trade here in the U.S.).
For the third quarter, Baidu said to expect organic growth of 5.4% to 8.6% and total sales of about $2.7 billion. Including an acquisition of travel-website Qunar, sales will fall as much as a couple of percent.
For the full-year, analysts expect earnings of $5.23 per ADS, or a slight dip from all of 2015. That puts the forward price-to-earnings ratio at just over 31. For comparison purposes, Alphabet trades at a forward multiple of about 23 and just reported second-quarter results where sales jumped more than 20% to $21.5 billion.
Questioning Baidu’s Future
Even prior to the medical mishap, investors were questioning Baidu’s search growth. The company might also be uncertain because it is actively diversifying into online travel, mobile payments and even self-driving cars. These activities are seen as a key reason profit growth has been nonexistent lately.
These are tougher businesses where even larger firms in China dominate. Ctrip.com International, Ltd. (ADR) (NASDAQ:CTRP) leads in online travel, Alibaba Group Holding Ltd (NYSE:BABA) is the equivalent to Amazon.com, Inc. (NASDAQ:AMZN) in the U.S. and has more payment capabilities. And we all know that Alphabet initially led the foray into cars that no longer need people to drive. Tencent (OTCMKTS:TCEHY) is another key rival in China.
Given the tepid near-term sales trends, more dubious profit growth, high valuation and diversification efforts, investors might want to sit safely on the sidelines for the time being.
Alphabet looks like a much safer bet right now and is more focused on its core search activities. That could change if Baidu can prove it can revive its online advertising franchise or be profitable in its new businesses.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.