There are some wicked expectations riding on China's leading search engine player and NASDAQ phenom Baidu.com (BIDU). On July 26, after the U.S. markets closed, the Beijing-based Net concern reported that earnings nearly quadrupled to $7.3 million and revenues vaulted 175% to $24 million year-on-year. Market reaction: Baidu's share price slumped 15% to around $78.50 in after-hours trading on signs the company's future growth would just be stellar—instead of phenomenal.
Ever since the search engine debuted on NASDAQ a year ago, global investors have flocked to Baidu.com as the perfect proxy play for China's fast-growing Net sector. The company's shares, which were priced at $27, soared to $122.54 on the first day of trading, Aug. 5, 2005 (see BusinessWeek.com, 8/5/05, "Baidu: Strong IPO, Stronger Rivals?"). The offering tapped into a deep investor hunger for the next Google (GOOG)—and a desire to profit from the Internet in China, where some 120 million-plus people now go online. At one point last August, Baidu's stock price hit a stratospheric $150-plus per share.
Things have calmed down since then. The stock has traded in the $70 to $90 range and the company currently has a market capitalization of about $3 billion. In recent quarters, investors have been cheered as Baidu.com generally exceeded earnings expectations; until its recent dip, it has been one of the best performing Chinese Net stocks traded on NASDAQ. Even with the 15% haircut in after-hours trading, Baidu's shares are still up roughly 25% on the year.
THIRD-QUARTER LETDOWN? In a conference call with analysts, Baidu Chief Executive Officer Robin Li pointed out traffic growth was robust, even though "the World Cup soccer game took people away from the computer." He pointed out that Baidu raked in more than 90,000 online marketing-service clients vs. 74,000 in the first quarter. And he added that the July 13 launch of Baidu Space, which allows users to create personalized home pages, photo albums, and other social-networking functions, snagged 100,000 registered users in less than 24 hours.
That's all good news, but what chilled investor ardor some was the third-quarter guidance by Baidu Chief Financial Officer Shawn Wang, who forecast revenue growth in the 24%-to-28% range compared with the second quarter. From the end of the January-to-March period to the end of June, Baidu delivered a monster increase of 40%-plus. That "suggests a sizable deceleration," Citigroup Internet analyst Jason Brueschlke suggested on the earnings call. Li countered that second-quarter revenue growth was somewhat exaggerated by a comparison with the first quarter, during which China celebrates long New Year's holidays.
That issue aside, it is hard not to like Baidu's dominant position in China's still small but fast-growing search market. At the end of the first quarter Baidu had 44% market share, according to Beijing-based research firm Analysys International. Yahoo! China—owned by Chinese e-commerce company Alibaba, in which Yahoo! (YHOO) owns a 40% share—is No. 2, with 21%. Mighty Google, which in 2005, it should be said, generated about 25 times the revenues of China's entire paid-search industry, trails the pack with a 13% share.
STRATEGIC ALLIANCES. Google, though, is out to change that, and Baidu will need to defend its turf aggressively. In June, Google announced plans to sell its 2.6% stake in Baidu, acquired before the Chinese company's listing on NASDAQ (see BusinessWeek.com, 6/23/06, "Google Searches for a Home in China"). And both Yahoo! and Google need to succeed in the second biggest market of Internet users outside the U.S., and a search market that Morgan Stanley Hong Kong-based analyst Richard Ji expects to enjoy compound annual growth rates of 50% over the next three years.
Baidu's Li has also been entering strategic alliances with such players as IBM (IBM), Intel (INTC), and Nokia (NOK) to develop new search services. His most recent deal is with Hewlett-Packard (HPQ), which will pre-install Baidu search engines on two lines of HP computers it sells on the mainland. Li also thinks there is more Baidu can do to better serve advertisers on the site—and boost margins on paid search. One thing is certain: Global investors have huge expectations for Baidu.