Baidu Up 23% in 3 Weeks, Still Cheap vs. Google
Despite already lowered expectations this earnings season, the S&P 500 tech sector is still managing to underwhelm investors. In the early going for second quarter earnings reports, Microsoft (MSFT), Intel (INTC), IBM (IBM) and Google (GOOG) have failed to keep pace with the market after announcing results.
It’s not exactly encouraging that the best of the lot, IBM, is seen more as a cost-cutting story – layoffs -- than an organic growth story.
With that backdrop, you’d think a tech company with an estimated 80% market share in an emerging market where penetration is estimated to be just 40%, and that has grown per-share earnings 80% over the past five years, would be trading at quite the valuation premium. Yet Baidu (BIDU) China’s dominant internet search company currently trades at a trailing and forward PE ratio in line with its valuation during the financial crisis.
That dominant market share has earned Baidu a “narrow moat” rating from Morningstar (Full Disclosure: Morningstar is an investor in YCharts), one of the just 10% or so of the 1,500 stocks tracked by Morningstar to be tagged either narrow or wide moat. Interestingly, Baidu also shows up on Morningstar’s short watch list of 21 stocks with a potentially expanding moat.
Still, the Baidu narrative of late (at least until last week—more on this in a sec) was that it was vulnerable to an upstart. Qihoo 360 Technology (QIHU), which until a year ago was in the business of online security services, managed to grab an estimated 9% of China-language search feeding off of a popular web browser it launched in August 2012. That vaulted it from nowhere to the second largest Chinese language search engine behind Baidu. (A refresher course: Google is a non-event in Chinese language search engine traffic, having pulled out of the mainland in 2010 rather than cede to Chinese officialdom’s censorship demands. Google’s China-language search is now run out of a Hong Kong-based service, where gremlins have seemingly plagued it with speed and reliability issues that have kept potential users away.)
Another knock against Baidu will be familiar to Google investors: just because it dominates online PC-based search, can it dominate -- and monetize -- the move to mobile?
As this stock chart shows, investors clearly loved the Qihoo upstart story over Baidu.
But that story took a sharp turn on Monday July 15th. Baidu announced a $1.9 billion deal to purchase 91 Wireless, a subsidiary of NetDragon that runs the leading third-party mobile app stores for Chinese-language users. Baidu’s press release says 10 billion -- yes billion -- mobile apps have been downloaded from 91 Wireless entities. If the deal goes through, Baidu clearly will have established an impressive mobile footprint. Baidu's rise over the last three weeks has been sharp.
If you think mobile is the dominant story in the U.S., it’s a fraction of the potential that exists in China. Of the estimated 564 million Chinese online at year-end 2012, 420 million -- 75% -- were surfing via mobile. (Total U.S. population is 314 million.) As mentioned earlier, estimates are that more than half the China market is not yet online, according to the state-run China Internet Network Information Center (CNNIC). Yes, all data from China officialdom needs to be taken with a few grains of salt, but this survey is considered the best of the lot.
Baidu’s mobile gambit not only triggered a quick 10% rise in the stock price, but also set off some industry wide scrambling. Just a few days later, Qihoo confirmed it is in talks to buy the #3 search engine, Sogou, from Sohu.com. (SOHU). Even if Qihoo and Sogou combine search engines, their 15% market share would still be less than one-fifth the size of Baidu’s footprint.
Baidu has long operated with the shorthand Street descriptor of “the Chinese Google.” To be clear, the globe’s two dominant search engines operate on different scale: Google’s $300 billion market cap is nearly 10 times that of Baidu. Still, Baidu, feeding off the massive and massively growing Chinese online market has generated higher revenue and net income gains.
Both stocks trade at a 23 forward PE multiple. That would seemingly be growth stock territory, but interestingly the deep value Dodge & Cox management firm initiated a near 1% position in Baidu in the second quarter for its $43 billion International stock mutual fund. ING Groep (ING) and Weatherford (WFT) were the only other new names added to the portfolio, and each of those stakes were less than a half a percentage point.
The $3.2 billion Dodge & Cox Global fund bought Google last fall—during a period when its forward PE sank to below 17. In the second quarter it did not add to that stake, now 1.5% of fund assets. But Dodge & Cox Global also initiated a near 1% position in Baidu.
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at email@example.com. You can also request a demonstration of YCharts Platinum.
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