Last week after the Chinese central bank (PBOC) announced a 25 basis point rate cut, I gained enough conviction to take a long position on Baidu which has sold off greatly along with most other Chinese equity flotations this year.
The PBOC move made me believe that Chinese policy makers may engineer a bottom in their equity markets through a wave of easing. I decided to go shopping for the higher quality Chinese names which are on sale, BIDU being amongst the first that I am adding.
Despite the global economic slow down and Chinese deceleration of growth (from 9-11% to 6-8%), some trends
will continue and the growth of the Chinese Internet is one of them. It is projected that for the next 15 years, an average of 20 million rural Chinese will migrate to urban areas per year. Surely, many of these migrants will gain better access to the Internet through web cafes or computer ownership.
On top of the demographic fundamentals, BIDU has strong business fundamentals considering that Google which
in 2010 controlled 30% of the Chinese search market has closed shop in China. In that time, BIDU's search market share has risen from 67% to 77% and is still rising as Google maintains approximately 18% of the Chinese search which will continue to erode as they have discontinued the mainland servers. BIDU has been given the keys to a monopoly which has allowed it to easy on the marketing and improve its profit margin.
In addition to search, BIDU has made efforts to expand its business by rolling out a mobile platform in a JV with Dell to launch a mobile phone. It has also refocused its new business initiatives on adding services outside of search such as page personalization and a TV ad agency for online video. BIDU is not necessarily strong in any particular business outside of search. It would certainly be a challenge for BIDU to expand into other ventures that could post margins anywhere near what it earns on its search monopoly. For the medium term, there is still room for BIDU to grow its search business as Google continues to exit the market. BIDU also has over 2 billion in cash which it could use to fund new initiatives. There is a chance that BIDU could make a value destroying acquisition in the future or venture into unprofitable ventures such as online video. An example of this can be found in fellow Chinese online company SINA which eroded its margins after it began unprofitable gaming and online video websites.
From a financial fundamentals standpoint, BIDU has a rock solid balance sheet with very little debt and a cash horde of 2 billion dollars. As mentioned, this gives the company a lot of flexibility. BIDU has also shown strong performance on delivering earnings. This year it posted EPS of 3.35, up 88% from last year, and analysts expect BIDU to deliver over 6 EPS using conservative estimates. Sales have also increased (but not as strongly as earnings) by 76% over the last 5 years and 75% Q/Q.
From a management perspective, BIDU's Robin Li serves as the CEO and was one of two founders in the year
2000. Li has proven to be a brutally efficient leader who clearly understands the industry well. While Li cashed out of most of his BIDU holdings, his management team have put up solid return metrics including:
Return on Assets: 39%
Return on Equity: 55%
Return on Investment: 50%
Gross Margin: 74%
Operating Margin: 52%
Profit Margin: 45%
Although BIDU doesn't really have any direct comparable companies, I will take a look on how it is valued vs SOHU and SINA which are two other stocks in the same space that have historically been correlated.
| BIDU | SINA | SOHU | GOOG | |
| Market Capl | 41 B | 3.47B | 1.7B | 182.93B |
| Sales | 2.56B | 488M | 904M | 39.98B |
| EPS | 3.35 | 3.52 | 3.45 | 32.99 |
| Forward PE | 18 | 43.31 | 11.71 | 11.13 |
| Operating Margin | 52% | -13% | 30% | 32% |
| EBITDA | 1.49B | 28.5M | 355.2M | 14.8B |
| EV | 39.05B | 2.8B | 842.27M | 144.32B |
| EV/EBITDA | 32.82 | 98.25 | 2.37 | 9.75 |
The take aways from the comparable table is that the Chinese Internet space is highly dispersed. BIDU is unlike any of its closest competitors (if you could say it really has any). It is a behemoth by any standards and profitable in a huge way.
The icing on the cake is that despite continuing to grow and improve margins, the stock is historically cheap at 35 P/E and 18 forward P/E. The stock is 30% off of its 52 week high as the global growth fears and China growth fears brought down most of the Chinese tech stocks. Now that the PBOC has started to show signs of easing, this may in fact be a great buying opportunity for a high quality stock that was trading at a P/E of 65 just a year ago. Of course, earnings have increased dramatically since the stock was trading at those levels. I expect the stock to continue to trade at multiples in the 30 range; however, it is currently priced at 18 forward earnings.
I bought BIDU in the low 120's and my 6 month target is 160. And that is why I am long BIDU.
BIDU has a monopoly over the Chinese search market which has strong growth fundamentals which are uncorrelated to macro economic growth concerns.
BIDU has a fortress balance sheet with very little debt, loads of cash, and few operational concerns from a management perspective.
BIDU has delivered consistent growth and performance on nearly every metric (ROE, ROA, ROI, Sales growth, EPS growth) and is trading at historically cheap levels with a forward P/E of 18.
Summary
Risks:
Some kind of social unrest in China leads to a political crack down which effectively takes down
web traffic.Another governance issue with Chinese stocks such as fraud leads investors to more heavily
discount high flying names like BIDU.Other social networks in China take search traffic away from BIDU.
BIDU ventures into costly areas outside of search such as social media or on-line video which dilute earnings.
Does Baidu have a presence in other East Asian countries?
My concerns in Baidu are 2fold:
1) Forex exposure. The people that drive their profits, spend in renmibi. The company reports in USD. If the reports of the RMB being held back 40% are true, this could nuke the company, even if it grows.
2). There is a limit to its growth, because of its anchorage to the chinese government. Will people in other countries tolerate such a sanctioned search engine? It's limited to just china, which while enormous, is still a significant ceiling.
When China's ruling party's lose their grip, it will lose its domination. That won't happen for a few years yet, but it will happen. I'll agree with you that a short term long baidu seems good, but i wouldn't hold it for any more than 3-5 years.
My concerns:
Chinese companies cook their books.. from small startups to large state-owned enterprises.. and it is common knowledge. If you've ever done due diligence on Chinese companies for an M&A mandate, you will quickly realize how much fluff there is.
Baidu is not Google. They do not innovate like Google does.. and do not have the talent that keeps Google at the top of its industry. Rather, Baidu is heavily reliant on government support (China blocks access to many of Google's offerings and frequently shuts down Google altogether in the Mainland). Don't expect Baidu to gain much market share outside of China the way Google has in just about every other country.
Even with China's large population, it is the revenues/profit that Baidu can generate from users that have a more important impact on stock performance.. which Chinese users do not score very high in that department.
Disagree on your 2. Baidu might not be google, but they do innovate EXACTLY the same stuff as google. :)
edit: Your 1 is a point so many people miss, and I wish I'd said it.
But I can use google in china... And many people bypass the great firewall through proxies
I ain't really sure whether your bet is a trading decision or an investment decision, but if it is the former, I don't agree with your calls.
Remember that China hasn't proved any central bank credibility in the past. You believe in the fundamentals and did your homework of the company, which is good, but your decision is really based on the fact that the Chinese central bank will somehow prop up asset prices, and the stock will somehow be able to reap the side benefits of the easing.
But their recent easing announcement has to do more with their uneasiness of slower growth due to the uncertainty of the global demand. And despite their aggressive actions at the beginning of the global financial crisis, their stock market hasn't experienced a meaningful jump, which leads me to conclude that their central bank does not have the power to inflate asset prices as that of the Fed.
That's not my point. I view the central bank move as a catalyst that investor sentiment may begin to change as the Chinese policy makers switch to easing mode. BIDU is and has been a strong company that would be a clear winner if investment sentiment towards China improved. I believe it has been sold off despite firming business fundamentals and financial characteristics.
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