Baidu Is Betting on Mobile Search

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

Baidu's (NASDAQ: BIDU) dominance in the Chinese search business is under attack. The influx of mobile technology is not only taking down the PC industry, but also the companies that have been reliant on personal computers. Baidu is China’s largest search engine, and may threaten to rival Google globally, due to the massive Asian population.

Local competition is heating up

Baidu accounts for 75% of China’s desktop search business, but trails Easou in the mobile search market. It's also facing competition from Sina (NASDAQ: SINA)Qihoo360 (NYSE: QIHU) and Sohu.com (NASDAQ: SOHU) in the search battleground. Sina, mostly a social networking player, is starting to mount a serious challenge in search. On the other hand, Qihoo360 and Sohu are continuing to challenge for mobile search dominance.  

In the most recent quarter Qihoo 360 CEO, Hongyi Zhou said, “We are also very pleased with the progress we have made in search and mobile monetization, even though this business is still in its early stage."

Unexploited mobile search is becoming an attractive business segment in China. And that's why Baidu is throwing in so much cash to try to replicate its desktop dominance.

Smaller margins for mobile

The company’s push for mobile search is expensive. Its heavy investment in mobile search drove costs higher, and consequently put pressure on margins. Baidu's margins declined sequentially primarily due to an increase in administrative and selling costs. This cost unit was up 88% year-over-year as the company intensified promotions and advertisements towards popularizing its mobile search platform.

On a positive note, its daily mobile search users grew by 25% to 100 million during the quarter, with the growth largely attributed to the aggressive marketing campaign. Baidu is focusing more on enhancing its user experience than on monetization.  Securing the user experience, which guarantees growth in numbers and engagement means increased market share.

So the strategy is to increase market share and then monetize. With a large user base, even the slightest uptick in average revenue per user could push overall revenue.  Consider Facebook, whose ad revenue per user continues to oscillate within the $3 mark--yet this is still the its largest revenue generator. The social networking giant's members have been the driving force to this achievement.  Its $2.85 ARPU translates to billions considering its massive user base. This is where Baidu is headed.

Baidu stomps the comps

With a profit margin of 44.21%, Baidu sets the bar for its rivals, who are way behind. Sina, for instance, has a profit margin of 5.88%, while Sohu's profits are pegged at a margin of 7.71%. Baidu’s trailing 12-month P/E also makes it the cheapest among the trio.  The number 1 China search engine giant appears to be the most attractive fundamentally.

Baidu’s 77% gross margin trumps Google’s 58% and Facebook’s 73%. The huge gross margins will help when costs swell.  This also allows it to pursue different opportunities that may come down the pike.  More importantly, the company is able to run its marketing campaign without significantly messing with profits.

Baidu boasts a 44% ROE, as compared to Sina's 3%, and Qihoo's 14%. Additionally, the company's debt to equity ratio of 0.40 is at acceptable levels, despite being higher than its competitors. Nonetheless, with cash of $5.39 billion against a debt of $1.90 billion, Baidu should have no trouble with liquidity. Sina, on the other hand, only has a cash pile of $681 million, while Qihoo's cash of $951 million is balanced by $270 million in long term debt.

The bottom line

Baidu is certainly at the inception point of its next big thing. With the PC industry diminishing, Baidu needs to join the battle for on smart devices.  You have to be delighted at the way Baidu has attacked mobile search.  Soon, mobile devices will dominate much of the computing industry.  The competition will be intense and developing innovative products will be critical.

Moving forward, Baidu is definitely set to widen its user base for the mobile platforms.  In fact, its spending on mobile search may trigger a long term rally.  And that's because Baidu is betting heavy on an industry that will determine the future of computing.

Regardless of your short-term view on the Chinese economy, there may be opportunity in Baidu. The Motley Fool's brand new premium report breaks down the dominant Chinese search provider's strengths and weaknesses. Just click here to access it now.


Nicholas Kitonyi has no position in any stocks mentioned. The Motley Fool recommends Baidu, SINA , and Sohu.com. The Motley Fool owns shares of Baidu. 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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