No Simple Reasons Why Baidu Inc (ADR) Stock Looks So Cheap

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BIDU stock price - No Simple Reasons Why Baidu Inc (ADR) Stock Looks So Cheap

Baidu Inc (ADR) (NASDAQ:BIDU) stock looks ridiculously cheap. The BIDU stock price sits at barely 25x earnings — despite estimated 60% earnings per share growth this year. It’s the dominant search engine in China, with efforts in artificial intelligence, autonomous driving, and other areas providing potential catalysts going forward.

Recent news has been solid as well. Baidu posted a huge third-quarter earnings beat; the BIDU stock price dropped 11% and has dipped a bit more since then. It looks like Baidu stock simply has been forgotten as Chinese rivals like Alibaba Group Holding Ltd (NYSE:BABA) and Tencent Holdings Ltd (OTCMKTS:TCEHY) capture the headlines.

Alhough many investors see the recent decline as an opportunity — as InvestorPlace contributors Luke Lango and Nicholas Chahine both have argued this month — caution is still advised. BIDU still has gained 41% year-to-date, and a 25x multiple isn’t cheap. With concerns both in the legacy search business and the future of its diversification efforts, the story with BIDU stock simply isn’t as simple as it might appear on the surface.

BIDU’s Search Questions

Baidu is often referred to as “the Google of China,” given its dominant share in online search. But last year, growth in that business stalled out: Search revenue grew less than 1% year-over-year.

The bullish narrative is that 2016 something of a blip. Baidu was the subject of a government investigation, and a torrent of negative publicity, after a student died of cancer. Before his death, the student alleged he had found his substandard treatment option through Baidu — and that the company had promoted questionable practices through paid search.

Since that tragedy, growth has returned. What the company calls online marketing revenue rose 22% year-over-year in Q3, continuing a sharp acceleration. The figure actually declined 1.3% in Q1 before a 5.6% increase in Q2. Simply from a timing standpoint, the move by Baidu to close down a good chunk of its medical advertising business in the wake of the scandal seems to be the driver of the weaker recent performance. With that move lapped, Q3 numbers seem to show the company’s growth potential in a more normalized environment.

The Bear Case for BIDU Stock

But there’s more going on here than just a single event. Both Alibaba and Tencent have moved more aggressively into the advertising space. Increased mobile usage — driven in many cases by apps rather than browsers — provides more pressure. While Q3 2017 results look impressive, it’s worth noting that Baidu is hemorrhaging customers. The figure has declined 22% in just two years.

The bear case for BIDU stock is that search will decline going forward, given competition, lower CPC (cost per click) rates, and increasing mobile app use. Ironically, it’s somewhat similar to the bear case for Google — now known as Alphabet Inc (NASDAQ:GOOG,NASDAQ:GOOGL) — earlier this decade. GOOGL stock has shrugged off that bear case; it’s quadrupled from 2010-2011 levels. But Alibaba and Tencent seem more dangerous competitors for Baidu than Microsoft Corporation (NASDAQ:MSFT) and Yahoo! (now part of Verizon Communications Inc. (NYSE:VZ)) were for Google.

BIDU Moving Beyond Search

Google managed to quell those search concerns in large part by diversifying its business. The additions of Android and YouTube, most notably, helped the company manage CPC rates — which continue to decline.

Baidu is taking a similar tack, moving from being the “Google of China” to something closer to the “Alphabet of China.” Its iQiyi video unit actually is more similar to Netflix, Inc. (NASDAQ:NFLX) than YouTube, but it gives Baidu a viable, and fast-growing, presence in video. It’s investing heavily in artificial intelligence, as Chris Lau detailed last month. And Baidu has an autonomous driving unit, akin to Alphabet’s Waymo.

Like Alphabet’s “Other Bets” division, those efforts have hit Baidu’s near-term profits. The question is whether that spend is worth it. Baidu’s non-search businesses have the same potential as Alphabet’s. While I remain skeptical of Google’s businesses beyond advertising, Google at least has real potential with Waymo, Nest, and its hardware business. iQiyi aside, Baidu’s efforts are much more early-stage — and much more risky.

Indeed, one Chinese analyst told marketing site TheDrum that “AI in China is a lot of hot air,” and well behind U.S. efforts in the area, in particular. And if users and marketing customers fade, the data edge that Baidu holds at the moment does too.

The BIDU Stock Price Makes Some Sense

The point here is not necessarily that BIDU stock is a short opportunity. Rather, it’s that the story isn’t quite as simple as headline numbers and labels like “the Google of China” would suggest. There are real risks here, between questions about the growth profile of the search business and the potential of Baidu’s diversification efforts.

At the moment, the risks seem enough to stay away from BIDU stock — at least for now. The chart doesn’t look particularly strong, Chinese economic and regulatory questions persist, and valuation is cheaper than peers, but more expensive than the market.

Obviously, that could change — quickly. An acceleration in search or big wins elsewhere could reignite confidence, and send BIDU back toward the all-time highs reached in October. If Baidu indeed becomes the Alphabet of China, its stock may follow the same trajectory as GOOGL. But it’s got a lot of work left to do.

As of this writing, Vince Martin has no positions in any securities mentioned.

After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.

 


Article printed from InvestorPlace Media, https://investorplace.com/2017/12/no-simple-reasons-why-baidu-inc-adr-bidu-stock-looks-cheap/.

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