Has Baidu Become a Quiet Sleeper?

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

Despite its massive market share dominance and continued revenue growth, Baidu (NASDAQ: BIDU) has languished this year, down nearly 11% on a year-to-date basis as of this writing. While some of the weak performance can be attributed to a series of downgrades on the stock, another part derives from the surging competition from new market entrant Qihoo 360 Technology (NYSE: QIHU). These factors have created a backdrop which seems to have lulled investors away from the stock. The result is that Baidu has become an under-appreciated gem that you should take advantage of at current levels.

Analyst Activity

In October alone, Baidu has been the subject of several analyst downgrades followed by a single upgrade. First Jefferies downgraded the stock to a hold, citing, amongst other things, concern over increased competition from Qihoo. The next day, Raymond James dropped its rating on the stock, although the decrease left their rating at Outperform. Lastly, Credit Suisse joined the party by dropping its rating to underperform, again on concerns over increased competition.

Finally reversing the above trend, Macquarie upgraded the stock to Outperform, stating that it believes the market share losses will ultimately be smaller than expected and that margin compression will be gradual. Their price target of $160 is just above the stock’s current 52-week high and is very near its all-time high. A return to this level would represent a very healthy return from current levels.

A Look at the Competition

As stated above, Qihoo is Baidu’s main competitor in the Chinese search market. Having been released just a few months ago, the company has already snatched as much as 10% of the market, taking primarily from Baidu; prior to the release of Qihoo, Baidu was believed to control roughly 85% of the search market. The new entrant has made its presence felt in a significant way and continues to grow.

Baidu has enjoyed nearly exclusive control to the Chinese market ever since Google (NASDAQ: GOOG) completely pulled out of China over censorship concerns. For those who do not remember, the U.S. search giant was asked to cooperate with the Chinese government on a variety of topics inconsistent with its normal practices. As a result, Google left what has become the single largest Internet market on the globe.

Given Google’s exit and Baidu’s nearly exclusive control, it is not surprising that the arrival of an alternative has had an immediate impact on the division of market share. This is no different from the progression that took place in the U.S. While many search engines popped up and quickly gained market share, most faded just as quickly. A few months after the release of the first competitor Baidu has seen in some time, it is far too soon to consider Qihoo a “Baidu-killer.” Furthermore, with the sheer size and growth of the Chinese market, there is still plenty of room for both companies to grow rapidly.

The Trade

While Baidu’s stock has not been a big performer thus far this year, it continues to possess very attractive upside potential. As the Chinese economy begins to stabilize and return to a state of significant growth, even with the emergence of a legitimate competitor, the company is in the proverbial driver’s seat with regard to a critical technology. As much as you may want to root for the young upstart – we Americans love an underdog – Baidu is as critical within the Chinese economy as Google is in the U.S. The lagging performance this year should, as such, be seen as an opportunity to establish a position at an attractive level.

Dig Deeper

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Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Baidu and Google. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.

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