Getting In on Chinese Internet Growth

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

In many parts of the developed world, internet penetration is about as high as it can go. As such, one could argue that these internet markets are saturated, which makes the maintenance of high growth challenging. In emerging markets, particularly in Asia, the opportunities for growth may be far higher. With low, but rapidly accelerating internet penetration, China looks attractive as an internet market, aside from already being the world’s largest consumer market. One company has so far managed to corner this market in a way reminiscent of Google. I speak, of course, of Baidu (NASDAQ: BIDU).

Profile

Baidu, headquartered in Beijing and employing around 16,000 people, is China’s largest internet search provider. With over 70% share of the Chinese market, the company is regarded as the “Google of China,” and in fact greatly benefited from Google’s exit from the region leaving them with a near-monopoly. In addition to its search engine, the firm also offers e-commerce and marketing products, serving consumers and enterprises.

Chinese Growth Concerns

China has been unloved by the market in recent years. For the most part, this is due to fears over a slowdown of Chinese GDP growth and the risk of a “hard landing” for the world’s second largest economy. Indeed, growth has slowed considerably in the last few years, approaching levels last seen in 2009. Still, at around 7.4%, GDP growth is still well ahead of any of the developed economies, and things may be improving. Recent figures from HSBC and the Chinese National Bureau of Statistics suggest that the Chinese slowdown may be hitting a bottom, with PMI’s of manufacturing and non-manufacturing sectors showing some slow but steady growth. This may be an interesting time to reconsider China.

Earnings

2012 Q3 results were strong, despite missing expectations slightly. Revenue missed by about $5 million, but nevertheless was up almost 50% YoY. Operating profit was also up substantially at around 48.1% YoY and customer acquisition was similarly impressive. B2C segments continue their strong performance according to management, while B2B has been facing increasing competition from new as well as established peers. In the search service segment, competitor Qihoo (NYSE: QIHU) recently started its own search platform which immediately snapped up 10% of the Chinese market share. One worry is the adoption of mobile technology, in which the company has been relatively slow compared to internet giant Google (NASDAQ: GOOG). However, it is estimated that Baidu currently spends about a quarter of R&D funding on cloud and mobile computing research.

Valuations and Metrics

Baidu currently trades at 21.7x earnings and at 9.11 to book. The P/E is historically low at the moment. Baidu has a staggering operating margin of 51.4% and an equally massive 50.4% return on equity. YoY quarterly earnings growth is approaching 60%. These metrics are excellent, certainly compared to its American counterpart Google. Google trades at 21.8x earnings but only 3.37 to book. However, where Google really trails is operating margin and return on equity. Google’s operating margin is at 28%, and return on equity is at about 17.2%. The difference here is quite striking.

Bottom Line

As China appears to be reemerging from its recent slump, investors are turning back to the economic powerhouse in search of bargains. Internet technology is one of the most promising sectors in China, where one company has emerged with a near-monopoly. The “Google of China” continues to deliver excellent results with massive growth and market share despite competition from new entrants. For those seeking growth in the world’s largest consumer market, Baidu may be an interesting option.  


DUJames 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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