This Search Engine Is a Buy

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Credit Suisse has recently downgraded Baidu (NASDAQ: BIDU), China’s largest search engine, to “Underperform” on concerns that it would use $1.5 billion of long-term debt it raised on last November for funding acquisitions. The company reported significant EPS improvement in the last quarter compared to the same quarter a year ago. I tend to disagree with the downgrade and expect the share price to stabilize going forward.

Credit Suisse analyst Wallace Cheung writes:

We expect Baidu to use proceeds for M&A and see potential targets as: (1) Kingsoft (in order to hedge against the risk of Qihoo (NYSE: QIHU)). Kingsoft, the No. 2 online security company, looks a good candidate for investment; (2) UCweb: Browsers are still the main entry point for mobile search and UCweb has a 30.5% share in the local mobile browser market, according to our proprietary survey; (3) Sina Weibo (NASDAQ: SINA): Baidu is able to increase mobile user engagement. However, we take Weibo and Autonavi’s recent cooperation on map service as implying Weibo is a less likely candidate…

…We rate Baidu UNDERPERFORM; as M&A is both costly and risky; but note calculated risk is part of the business.

Credit Suisse cut Baidu's stock price target to $80 from $82 earlier.

Positive Catalysts for Baidu’s Stock

Baidu Enjoys 80% Search Market Share in China: Baidu’s search revenues from China increased substantially over the past three years, partly due to Google’s (NASDAQ: GOOG) exit from the Chinese market in 2011. Baidu offers a Chinese language search platform on its Website,; and a Japanese language search platform on its Website, Baidu’s virtual monopoly in the Chinese search market could be challenged with a new player Qihoo gaining traction in the industry. Therefore an acquisition may be just in the cards for Baidu, in order to square off the position.

Baidu Enjoys 35% Share in Chinese Mobile Search Market: In order to raise its current market share in mobile, Baidu has taken some sound steps in this space such as launching its own mobile OS and browser in the country. The company is focusing on monetizing from the growing mobile ad space. By launching mobile OS and browser, Baidu will have app developers helping the company boosting ad revenue in the smartphone and tablets market.

Baidu’s Debt to Equity Ratio Reasonable

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BIDU Debt to Equity Ratio data by YCharts

Baidu’s debt to equity ratio is reasonable, compared to Google and Yahoo (NASDAQ: YHOO). It’s declining steadily since 2011. On November 20, 2012 Baidu raised a total $1.5 billion debt in two parts, with the first $750 million by issuing 2.25% bonds due in 2017 and the second $750 million by issuing 3.5% bonds due in 2022. Baidu is expected to use some this newly raised bond for funding acquisitions. With a reasonable debt level it makes a lot of sense for Baidu to go for some acquisitions. Any such acquisition will be EPS-accretive in the long run and therefore should be considered positive for the stock.

Baidu’s ROIC Attractive for Value Investors

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BIDU Return on Invested Capital data by YCharts

ROIC (return on invested capital) measures whether a company has an economic moat -- the ability to earn returns on its invested capital above that capital's cost. The higher the ROIC, the more efficiently the company uses capital. While many look to ROE (return on equity) as an indication of how effective management has been at running the business, I prefer looking to ROIC because it cannot be increased by adding more leverage.

With a ROIC of 47.39%, much higher than that of Google and Yahoo, and a reasonable debt on the book, Baidu is an excellent value investment idea in the search and display ad space. I would recommend buying the stock on dips.

Anindya7 has no position in any stocks mentioned. The Motley Fool recommends Baidu, Google, and SINA. The Motley Fool owns shares of Baidu and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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