Do Investors Forget Who They are Dealing With?

By Chad Henage - July 31, 2012 | Tickers: BIDU, GOOG, SINA | 0 Comments

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I sometimes wonder if investors completely forget what companies have done over the last several quarters. In particular the Chinese Internet search giant Baidu (NASDAQ: BIDU)is a company that consistently beat earnings expectations, and yet it seems in between quarterly results, investors forget how well the company is performing.

One Trick Pony:

A recent article pointed out that Baidu has nearly 80% market share in China. The company is regularly compared to Google (NASDAQ: GOOG) as both receive the majority of their revenues and income from Internet search and related advertising. The concern is, as Internet search growth slows down, that advertisers will be willing to spend less money with these companies.

If This is The Company's One Trick, it's Working Pretty Well:

Looking at the company's current earnings report, you can see how impressive the company's growth is. With revenues up 59.8%, and diluted earnings-per-share beating expectations by $0.13, Baidu is truly on a roll. While it's true that, as Rick Munarriz of The Motley Fool pointed out, the company caught a tax break that assisted results, Baidu is still growing faster than any of their counterparts. The company showed strength in nearly every important financial metric. For instance, online marketing revenues increased 59.7%, and traffic acquisition cost stayed low at just 8.3% of total revenue. Considering that Google regularly spends 24% to 25% on traffic acquisition, this last number is amazing. In addition, active online marketing customers increased by 18.1%, and revenue per customer increased 34.8%. The strength of these operating results directly led to impressive financial performance as well.

More Cash & Impressive Forecast:

Looking at Baidu's financial statements, we see cash and investments increased 28.76% on a year-over-year basis. This was primarily driven by over $360 million in free cash flow in the current quarter. In addition, the company forecast that in the 3^rd quarter of 2012, they expect revenues between $983 million and just over $1 billion. To get a sense of the value that Baidu offers investors, we have to look at their competition and see if there are alternative choices that might be better.

Something Doesn't Make Sense:

We've already mentioned Google, and as the dominant search engine in the United States, the company's comparison to Baidu is a fair one. Both companies dominate their respective markets, the difference is Baidu is growing in a much less saturated market, with a much larger opportunity. To define this difference is fairly straightforward: Google's expected forward growth rate is just over 16%, while Baidu's expected growth rate is nearly 40%. With Google selling for just over 14 times its 2012 earnings estimates, you would expect that Baidu would sell for a much higher multiple. While Baidu's multiple is 76% higher, the company's growth rate exceeds Google by 145%. You can see there is somewhat of a disconnect between the relative valuations of these two search giants. As further proof that there could be opportunity here, consider that SINA Corporation (NASDAQ: SINA) which operates a Twitter-like micro blogging site, is expected to grow at about 28%, yet sells for a 2013 multiple of over 38. SINA is expected to grow slower than Baidu, and yet sells for a higher multiple, even using 2013 earnings, this doesn't seem to make a lot of sense.

Conclusion:

With a clear lead in Internet search and advertising in China, Baidu is a fast-growing option in a much less penetrated market than the United States. While I've read others express concern about a potential slowdown in China's overall economic growth, this misses the point. Still over half of the Chinese population is not even online. In addition, with Baidu being named as the default search engine for iPhones sold in China, as Apple sells more iPhones, the company's presence will become even more dominant. Given that on a relative basis the company shares are cheaper than several other competitors, investors should give serious consideration to adding Baidu to their portfolio.

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