Investors Searching for Baidu's Next Chapter

APRIL 22, 2011   THE WALL STREET JOURNAL

By TOM ORLIK

Investors have found Baidu's story riveting.

And with good reason. It is the dominant search engine in the fastest-growing large economy in the world. Throw in an e-commerce sector that grew 73% to $68 billion in 2010, according to Morgan Stanley estimates, and the opportunity looms large.

For its part, Baidu has done little to disappoint. Revenue grew 78% year-on-year in 2010. The outlook for results in the first quarter of 2011, due to be reported next week, is similarly solid. Management guidance is for revenue growth of 84% to 89% year-on-year.

Baidu also stacks up well against others in China's e-commerce sector. Proven technology, a 75% share of the mainland's search market and several years of real and growing profits look impressive. That's especially the case when it is compared to pricier plays like video-sharing platform Youku, which operates in a more competitive space and has yet to move into the black. True, negative chatter about copyright violations continues but has done little to dent business growth or investor appetite.

The catch is that with the China e-commerce story now well-known, Baidu will have to find new ways to impress investors. Some are already in the works, but as Google investors know well, adding to search supremacy is no easy task.

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Revenue grew 78% year-on-year in 2010. The outlook for results in the first quarter of 2011, due to be reported next week, is similarly solid. Above, the Baidu Technology Innovation Conference in Beijing in September.

Qiyi, Baidu's new online video platform, has already generated significant traffic, but has yet to show a profit. Baidu is also testing a web browser that will contest the space occupied by Microsoft and Google, although given the competition, success is far from assured.

Plus, Baidu's stock isn't cheap. The shares are up more than 50% this year-to-date. A price-to-earnings ratio of 60 may be justified by expected earnings growth, but suggests limited upside. Earnings growth in 2010, meanwhile, was flattered by the departure of Google from the Chinese market—gifting Baidu an extra chunk of market share. The company also benefited from comparisons to a relatively weak 2009.

Macroeconomic headwinds may also loom, even if Baidu's advertising-driven model is defensive relative to some other China Internet stocks. Slower economic growth and higher inflation would also strip some of the glamour from China's Internet story. So while Baidu continues to wow, the bar is getting higher.