Baidu (BIDU, Financial) is arguably the largest search provider in China. The company is growing rapidly and reported revenue of $3.6 billion in 2012 with an operating margin close to 50%. It generates nearly 60% of its revenue through search advertising and has a staggering 80% market share in the Chinese internet search segment; nonetheless in the mobile search market Baidu is still a relatively smaller player. After search advertising, Baidu generates the remaining revenue through display advertising and search content partnerships. I believe, the company may have a 20 to 25% upside on the stock price going forward.
Key revenue streams
Baidu’s key revenue streams are search advertising, display advertising and several content partnerships. Search advertising contributes a massive chunk to the overall revenue. In the Chinese search advertising domain Baidu holds the highest (80%) market share. Display advertising contributes roughly 32% to the total revenue. This primarily includes the revenue generated through traffic on its websites. Finally, content partnerships with third party websites contribute approximately 8% to the overall revenue.
Target customers and revenue model
Baidu deals with online marketing for a diverse group of organizations. The potential clients include small to medium sized enterprises, large Chinese corporations and subsidiaries of large global corporations located in China. In 2011, Baidu reported a base of more than 480 thousand active customers from a variety of industries such as online gaming, financial services, transportation and information technology.
Baidu's unique business model generates revenue through two separate sets of services. Pay for Performance charges on the number of clicks by online users on the ads displayed and in contrast, the Brand Link service charges its customers for the duration of the ads displayed on the search results. This offers its potential clients a high level of flexibility when using Baidu's platform for marketing and promotions.
Areas of growth
The growing popularity of smart phones in China presents a splendid opportunity for Baidu to spur growth through a new segment. The consumer shift in browsing web through PC to smart phones has compelled Baidu to invest heavily in mobile search. Going forward, the company will aim to grow further on its 35% market share in this segment. Baidu has exhibited strong initiative and is moving in the right direction to launch the new mobile phone platform.
Other than its mobile phone platform and browser, Baidu is now making a shift and focusing on a different vertical all together. The company believes the video vertical could be a key revenue driver moving forward. Last year, the company bought more stakes in iQiyi (Chinese video site) to own controlling rights. However, the eventual aim of this move is perhaps to capitalize on the video business to further develop a larger user base that increases revenue from display advertising. Usage of iQiyi from other platform devices such as smart phones and tablets will further bolster the business.
Potential Threats
Baidu has an extremely dominant position in the internet search market, nonetheless the competition is intensifying and it now faces a stiff challenge from Qihoo. Qihoo is a software company that also offers a web browser. The company only has presence in China and had an active user base of 273 million for its web browser by the end of first quarter of 2012. The company is growing in awareness and gaining traction in the Chinese marketplace. Within the search advertising domain Baidu also competes with Google. Google has an approximately 5% market share in China. Baidu also faces a stiff challenge from other domestic players such as Sougou, Yisou, Sousou, and Zhong Sou. Google has a market cap $274 billion and reported revenue of $42 billion in 2011. The company is a global leader in internet search; however penetration in the Chinese market has been a struggle. As Baidu plans to grow in the mobile search market, it is imperative to highlight that the existing mobile search market in China is already fragmented. Currently, Tencent and Easou also are highly active in this segment and hold substantial market shares.
My Rationale for an Upside in the Stock Price
Baidu’s RPS (revenue per search) has increased consistently since 2007. In 2012 RPS touched $5.71 per 1000 searches and going forward, I expect it to blow past the $8 per 1000 searches mark. Baidu holds a staggering 80% market share in the internet search domain and the aggressive growth in ad spending could take the RPS past $9.5 per 1000 searches. However, a lot depends on if the competition intensifies further or eases up. If the RPS exceeds $9.5 (market conditions look favourable) and the margins remain constant, there could be a 8% to 10% upside in the stock price. Nevertheless, if the launch of the new Chinese search engine introduced by the government to control Baidu’s growing monopoly results in RPS not exceeding the $7 mark, then we may witness a heavy downside in the stock price.
In Baidu's case it is imperative to highlight that searches per internet user are on a rapid increase in China. As per Trefis, average searches per internet user during a month in 2012 stood at 72. I expect this number to grow with the increasing popularity of smart phones and tablets in China. If the number blows past 100, then we should witness a heavy upside in the stock price. The tablet and smart phone penetration in China is rapidly increasing and going forward, I expect the growing adoption of smart phones and tablets should benefit Baidu’s business.
