Backgrounder on China Search Engine market: Similar to US, the search engine business in China generates revenue from advertisement. The size of the search engine market in China was RMB 3.21bn ($493mn) in Q12011 and represented 37.5% of total online advertising market. The online ad market is forecast to grow 27% p.a. from $3.7bn in 2010 to a conservatively-estimated $9.5bn market in 2014.
A major milestone for the company came in December 2009, when it launched and upgraded its ad system dubbed “Phoenix Nest”. It was aimed directly at both small and large corporate advertisers with a system strikingly similar to Google’s AdWords program. In 2010, Baidu became a major beneficiary of GOOG exit from China to Hong Kong. This allowed Baidu to increase its market share, as shown below. The two phenomena gave it a tremendous boost in last four quarters. However after 1H2011, the company would have tougher YoY compare.
The paid search market in China is a lot lower than the world average: 3% of GDP, while the world average is roughly 6% of GDP. In China the top search engine i.e. Baidu has average transaction value per ad click of $5, significantly lower than the average of $70 in the United States, thus it could increase to about $10, proportionate to China GDP and consumption pattern. Currently, what the company lacks in per-click earnings, it makes up in tremendous volume.
BIDU:
In terms of Internet ads, Baidu leads with 30% of a market comprised of numerous smaller competitors, the most significant of which is Alibaba, which holds a 9% share. CEO Robin Li, was formerly a staff engineer of dot-com boom search engine Infoseek. He is no stranger to the ways of Silicon Valley and many of Baidu’s functions and portal websites can be seen as amalgamated versions of Google, Yahoo and MSN.
A major milestone for the company came in December 2009, when it launched and upgraded its ad system dubbed “Phoenix Nest”. It was aimed directly at both small and large corporate advertisers with a system strikingly similar to Google’s AdWords program. In 2010, Baidu became a major beneficiary of GOOG exit from China to Hong Kong. This allowed Baidu to increase its market share, as shown below. The two phenomena gave it a tremendous boost in last four quarters. However after 1H2011, the company would have tougher YoY compare.
Going forward, market share growth in search will be limited and the company will have to rely upon organic growth from expected increase in China internet penetration (current 36%) and increase in on-line advertisement spend. Being aware of the same, BIDU is aggressively exploring additional growth avenues. These growth avenues will also serve as defensive measures in the face of new challengers.
BIDU is a aiming to go beyond browser and operating system layer, by implementing it “Box computing” vision; whereby its search box acts as an independent software utility that can be integrated with any consumer electronic i.e. PC, tablet, smart phone, Smart TV, Car dashboard, household appliances etc. In this manner BIDU wants to become a lifestyle utility. It was launched in September, 2010 and now has tens of thousands of software partners, offering various popular services such as calendar services, weather reports, micro-blog postings etc. The same forms the core of its mobile strategy and BIDU intends to expand the same beyond China, aiming at international markets.
BIDU’s online video portal, Qiyi.com achieved over 150 million monthly unique users in just 12 months after its launch. It mainly serves professionally produced media content and is in direct competition with Youku, Taodou. The effective browsing time of Qiyi.com more than doubled from 250 million hours in Q4 2010 to 560 million hours in Q1 2011.
Social media is a very promising but crowded area in China internet. BIDU’s announced approach is to integrate social with search and not to really develop an independent social network per se. However post meeting Marc Zuckerberg in December 2010, rumors about an alliance or a joint venture between Baidu and Facebook have been circulating. This rumor, if materialized would be a major catalyst and should not be ruled out. BIDU had few basic social features such as Baidu Post-Bar (discussion board), Baidu Knows and recently added social features such as Connect and Like. These features let users simultaneously publish their posts on multiple microblog accounts - a major craze in China. Management recently announced that registered users of these social features have grown at a rate of 10 million per month and they represent about a quarter of total traffic with faster growth than the web search.
BIDU is attempting to benefit from ecommerce wave. It launched a portal-like parallel homepage, Hao7 and intends to use it as a directory site and a gateway for ecommerce, including group-buying. However, such efforts are only incremental in nature.
Valuation: Thus BIDU’s core business of search-related advertisement has few years of growth left in it. At $121, the ADR trades at 40x NTM EV/EPS and 30x P/S. At a normalized level the P/S should not be above 5X (similar to GOOG). However due to China’s underdeveloped stage, the normalized P/S could be adjusted upward to 10X. Assuming an above market 50% revenue growth, the P/S would come below 10x in the fourth year. Any quarter that exhibits below 50% revenue growth would be the catalyst to bring the stock to $100.
Catalyst: Thus, the most important metric for BIDU is YoY revenue growth. Unless BIDU comes up with an alternative revenue engine it should lose its extra-ordinary growth premium. Any deal with Facebook could provide a second growth engine.
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