Company Report:
Baidu, Inc.
(BIDU)
Company: Baidu, Inc. (BIDU)
Current Price: $105.05
52-Week Range: $38.47 $115.04
Target Price: $126.73
Recommendation: Buy 40 shares
% Gain to Target: 20.6%
Summary:
Baidu is an Internet service provider based in China and Japan. The company has experienced
explosive growth since its inception in 2000. Internet usage in China is growing and Baidu
controls 76% of the search engine market in China. The company has a five-year annualized
growth rate in revenues of 106.9% and EPS growth of 151.2%. Immediate opportunities for
growth are present, especially with the recent difficulties that Google has experienced in the
Chinese market. Baidu is poised in an optimal position to expand in the Internet service market.
Baidu provides not only a comprehensive portfolio of products and services for potential users
and customers, but has also invested heavily in developing new products and technologies. The
recent implementation of the Phoenix Nest platform as well as recent strategic partnerships are
short-term catalysts that will continue to generate organic growth.
The discounted cash flow indicates a price per share of 126.73. The company has 20.6% to grow
to reach the target market. Due to qualitative and quantitative factors, I recommend a purchase
of 40 shares for the CFASP portfolio at a share price of $105.05 (as of 11/30) for a total dollar
investment of $4,202.
QUALITATIVE ANALYSIS
Market:
China is the fastest growing major economy in the world, averaging rates of 10% growth in GDP
over the past 30 years. Figure 1 illustrates the rapid growth experienced by China for the past 10
years. At the current rate of growth, it is estimated that the Chinese GDP will surpass the U.S. in
roughly 18 years.
Year
2001
2002
2003
2004
2005
2006
2007
2008
2009
GDP Growth Rate
8.3%
9.1%
10%
10.1%
9.9%
11.1%
11.4%
9.6%
8.7%
Figure 1
In addition to rapid economic growth, China is also experiencing a rapid increase in Internet
usage. From 2006 to 2010, the Chinese Internet search engine market experienced an annual
growth rate over 30%. There is additional growth potential in the future as well. Currently, only
29% of the Chinese population are active Internet users, compared to 68% in the United States.
The majority of current Internet users in China are under 30 and use the Internet for media
based applications. The Chinese market is growing rapidly at a rate sufficient to fuel continued
growth for Baidu for the immediate future. Over the next five years, the number of businesses
placing advertisements through Chinese search engines is expected to increase at a rate of 17%
annually.1 Future growth for Baidu will likely arise from an increase in new users, customers and
Baidu Union members, rather than from an increase in market share.
Company Profile:
Baidu is the current leading Chinese Internet search provider. Founded in 2000, Baidu was
incorporated in the Cayman Islands. Since that time, Baidu has grown rapidly and accounted for
76% of the total Chinese language web search market in China in 2009.2 Currently, the
[Link] website is the largest website in China.3 Baidu started a Japanese subsidiary in
January 2008, which provides the same search capabilities for Japanese users. The goal of the
company is to provide the best method for users to find and access information on the Internet.
The purpose is achieved through a variety of free and pay products and services.
Baidu focuses on three groups of online participants: users, customers, and union members.
Users: Internet search services are provided to end users enabling the access of online
information including web pages, news, images, and multimedia files. Access is achieved
through links provided on the search engine. Additionally, Baidu offers online community and
entertainment platforms such as Baidu Knows and Baidu Space. Instant messaging is also
available, as well as an e-commerce platform known as Baidu Youa.
Customers: Baidu provides online marketing services for Pay-for-Performance (P4P) customers.
Services are provided through an auction-based system that allows customers to bid for priority
placement of links in keyword search results. Customers can use both query and non-query
sensitive advertisements that include text links, graphical advertisements, and other forms of
online advertising. Baidu had over 223,000 active online marketing customers as of December
31, 2009.4 This model is clearly similar to Google; a more detailed comparison between the two
companies is discussed later in this paper.
Baidu Union Members: A large number of third-party web content and software providers
partner with Baidu. These members can display Baidus customer promotional links on their
online properties. Some members also include a Baidu search box or toolbar on their website.
These partnerships allow Baidu to display relevant search links on additional websites,
"China Search Engine Marketing - Chinese Internet Usage." Search Engine Optimisation (SEO) | Chinese
SEO | Software Development | Conversion Rate Marketing. Web. 20 Nov. 2010.
<[Link]
2
Global Company Intelligence. Financial and Strategic Analysis Review. October 2010. p 9. Print.
3
Ibid.
4
"Baidu, Inc. (BIDU.O) Company Profile | [Link]." Business & Financial News, Breaking US &
International News | [Link]. Web. 22 Nov. 2010.
<[Link]
increasing web traffic. When Baidus links are displayed on a partners website, fees generated
through clicks are divided between Baidu and that partner.
Products and Services:
Web Search: Baidus primary service for users is a web search engine. This product is highly
visible to consumers, evidenced by the high usage and website visits. The home page features a
prominent search box that loads rapidly. After entering a search query, users are presented with
a list of search results. Users are able to click on the desired websites that meet desired needs.
In addition to the basic web search, other integrated features are included on the home page to
assist users in finding data more readily. Figure 2 is a list of integrated features included in
Baidus web search product.
Feature:
Related Search:
Description:
Provides alternative search terms based on the original
query.
Search in Results
Enables users to conduct additional searches within the
results of an initial query.
Search Term Suggestion
Displays a list of suggested search terms as the user inputs
search criteria.
Search by Chinese Phonetics (Pinyin)
Enables users to conduct quick searches by entering
Chinese phonetics with letters of the English alphabet rather
than Chinese characters.
Spell Check
Advanced Search
Snapshots
Stock Quotes
Weather
Train and Flight Schedules
Suggest alternative search terms when a search appears to
contain misspelled words.
Enables users to create more focused queries by employing
additional search criteria.
Provides snapshots of web pages, allowing users to view
web pages that cannot be quickly or easily opened.
Provides links to stock information for companies listed on
exchanges in China.
Enables users to quickly check the weather.
Enables users to quickly check domestic train and flight
schedules as well as international flight schedules
Figure 2
Post Bar: The Baidu Post Bar is a query-based searchable community that allows users to
exchange views and share knowledge and experience. Users can search, read and browse
Internet message boards and post messages to other members of the community. The Post Bar
covers a broad range of topics and interest areas and even allows users to post and share video
clips in approximately 88,000 online communities.
News: Baidu news provides links to sources of local, national, and international news.
Additionally this service presents news stories in a searchable format within minutes of
publication on the web. Baidu News is typically updated every three to five minutes throughout
the day. Baidu currently holds a license issued by the State Council News Office to provide
Internet news services.
Baidu Knows: Baidu Knows is a service that provides users with a query-based searchable
platform for sharing knowledge and experience. Registered members can post specific questions
for other members to answer. Any user of the Baidu can search, read, and browse the questions
and answers provided by this service.
Image Search: Baidus image search capabilities allow users to search millions of images on the
Internet. This service is similar to Google, however Baidu allows for additional screening criteria,
such as image size, color, or file type.
Baidu Space: This service allows users to create personalized web pages in a query based
searchable community. Users can post blogs, photo albums, and certain personal information on
the customized homepages as well as establish online communities of friends. Registered
users can also set limits on who can access certain content on their homepage.
Instant Messaging: Baidu Hi, an instant messaging service was launched in June 2008. The
service allows register users to communicate in real time with other users. The service provides
the functions of chat, groups, and personalization as well as integrating search services and
online communities.
Desktop Search and Toolbar: Baidu desktop search is a free, downloadable tool that allows users
to search files saved on a personal computer without using a web browser. The Baidu toolbar is
free, downloadable software that integrates with a users web browser to facilitate the use of
Baidus search capabilities.
Safety Center and Anti-Virus: Baidu Safety Center is a free virus scanning, system repair and
online security evaluation service. The anti-virus product is an online marketplace that offers
users the latest anti-virus software products and news. Baidu partners with major Chinese and
international anti-virus software companies to provide this product.
Internet TV: Baidu Internet TV (aka Baidu Movies and Television) enables users to search, watch,
and in some cases, download free movies, TV, cartoons and other programs hosted on Baidu
servers. Content providers who have valid copyrights to the programs have provided these
programs. Baidu established Ding Xin, Inc. in early 2010 to operate Baidu Internet TV.
Providence Equity Partners, a private equity firm, partnered with Ding Xin in March 2010 to
provide $50 million in investment capital.
E-Commerce: Baidu Youa, a consumer-oriented e-commerce platform was launched in October
2008. The vision was to allow merchants to sell products and services at Baidu-registered estores. Additionally, customers can use a Baidu-branded payment system, BaiduPay, to
complete their purchases. Baidu Youa possesses the traditional functions of a consumer-toconsumer (C2C) online trading platform while providing consumers with extensive, useful
information about the products being purchased. Additionally, in January 2010, Baidu entered
into a partnership with Rakuten Inc., the largest e-commerce website in Japan. The goal of the
joint venture is to build a business-to-business-to-consumer (B2B2C) online shopping mall for
Chinese users. Rakuten owns 51% of the joint venture compared to Baidus 49%.
Marketing Platform: The majority of Baidus revenues (over 99%) are generated by online
marketing activities. In 2009, Baidu launched Phoenix Nest, an online marketing platform for
professionals. The Phoenix Nest platform allows customers to reach users who search for
information related to their products or services. The platform serves as an online marketplace
that allows customers to bid for priority placement in search results. Baidu utilizes technology
that allows for quality ranking of keywords in addition to pricing. Baidu is able to charge a
premium for higher quality keywords. As a part of the marketing platform, Baidu also offers
account management, keyword suggestions, and performance reporting to assist customers in
achieving a high ROI from marketing expenditures.
Research and Development:
Research and Development (R & D) is essential to Baidus long-term viability, and has been
appropriately prioritized by the company. Baidu employs 1,726 employees in its R&D
department, which is almost 25% of the total number of employees. R&D activities focus on
Chinese language processing, information retrieval and high performance computing. In 2009,
the company spent CNY422.6 million ($63.5 million USD), a 47.6% increase compared to 2008
expenditures. Additionally, 2008 expenditures were 103% higher than 2007 expenditures. Year
over year growth of R&D expenditures is listed in figure 3. These cost increases can be
accounted for by an increase in the number of R&D staff and their compensation.
R&D (% growth from prior year)
2009
47.56%
2008
117.52%
2007
89.98%
2006
138.17%
Figure 3
R&D expenditures as percentage of total revenues are increasing at a rate of 1% a year. In 2007,
these expenditures made up 8% of revenues. In 2009, R&D was almost 10% of revenues. These
revenues will most likely increase over the next few years before gradually reaching a plateau.
Expenditures can slowly decrease once the company growth rate slows. However, slowing
growth rate is not expected in the immediate future.
Sales and Marketing:
Baidu invests significantly in sales and marketing operations. Of more than 7,000 total current
company employees, almost 4,500 are devoted to sales and marketing; this equates to roughly
60% of the company workforce. Historically, sales have been generated through a nationwide
network of third-party distributors. However, since 2005, Baidu has worked to develop a direct
sales force. Offices have been established in major cities throughout China, including Shanghai,
Beijing and major cities in the Guangdong Province. These established offices have increased
direct sales.
Baidus distribution network provides value-added services for Baidu by identifying customers,
collecting payments, assisting customers in setting up accounts, and suggesting keywords. The
network engages in marketing and education services directed at gaining new customers. Many
small and medium enterprises are located across a variety of regions within China; Baidus
network provides a cost effective way to provide superior service to these small companies.
Baidu is currently marketed primarily by word-of-mouth. As capabilities and products have
increased, more customers have recommended the service to other users. Additionally, the
company IPO in 2005 resulted in positive media coverage that has enhanced brand recognition
at minimal expense. Additionally, Baidu is able to leverage its distributor network to generate
additional market and brand awareness.
Life Cycle:
Baidus initial public offering (IPO) took place in 2005. Since that time, Baidu has experienced
dramatic growth. Revenues are expected to reach $1.2B USD in 2010. The company has
achieved a 106.9% annualized growth rate in revenues. Earnings per share have also grown
significantly, reaching 151.2% annualized growth rate over the same time period. Figure 4
displays the growth in revenues as well as earning per share achieved over the past five years.
Baidus growth rate is not expected to decrease substantially in the next few years.
Figure 45
As noted above, Chinese Internet usage is growing rapidly. With the market entry difficulties
that Google has experienced in China, Baidu has been able to capture additional market share.
The company has also recently expanded into Japan. Japan is a mature Internet search market
and this is Baidus first attempt to penetrate such a market. The Japanese venture so far has
shown very promising signs. However, company management still does not expect to see
significant revenues until 2011, when the market presence is more established. Baidu has no
immediate intention of competing head-to-head with Google in the established U.S. market.
However, Baidu would not be opposed to entering the U.S market if the company comes up
with new, innovative ideas that will provide a clear edge in the market.6
Baidu is expected to continue growing at a rapid rate for the next few years. As the market
begins saturate, the company growth rate will eventually decrease and profitability ratios will
decrease. Valuation multiples, such as the P/E, will also decrease as revenues grow, ultimately
moving toward the industry average.
Company Strategy:
Baidus fundamental strategy is to enhance offerings to customers as well as to increase overall
Internet search traffic. In order to improve search traffic, Baidu aims to improve search results
and user experience.7 Baidu recently implemented its Phoenix Nest platform to assist customers
5
Global Company Intelligence. Financial and Strategic Analysis Review. October 2010. p 19. Print.
Ha. Anthony. Baidu CEO: We tried harder than Google in China. Venture Beat. Nov. 15, 2010.
[Link]
7
Wuh, Paul and Michelle Ma. 3Q Strong, but no near-term catalysts. Samsung Securities. October 22,
2010. Print.
6
in purchasing advertising. Phoenix Nest has been a success, but future growth in revenues is still
expected.
In terms of product strategy, Baidu is focuses on developing contextual advertisements.8
Contextual ads depend on an advertising system that can scan the webpage the user is viewing
and display advertisements that complement the material. Currently, contextual ads account for
only a small amount of Baidus revenue. Google is the current leader in this sphere. Baidu plans
to focus on developing technology to gain market share. Baidu also plans to focus on building
user applications.
Baidus growth strategy has centered on connecting with new Internet businesses. Since
inception, the company has developed new Internet products and business to complement its
current offerings. This strategy has even included strategic acquisitions focusing on businesses,
assets, and technologies. In 2009 Baidu acquired certain intangible assets, including domain
name, software, trademark and non-competition agreements.9 Strategic partnerships have also
played a crucial role in Baidus growth strategy and will continue to do so in the immediate
future.
Competitive Environment:
Baidu operates in a highly competitive global market. Key competitors include Google and
Microsoft, which each have a strong global presence and brand. These companies provide web
search products, instant messaging services and other products similar to Baidu. Additionally,
both companies have more users, customers and more financial resources. Googles Chinese
website is a significant source of competition and currently has the second highest visit rate in
the country. However, as previously mentioned, Google faced obstacles raised by the Chinese
government that have severely impacted operations in China, further detailed below. This has
resulted in a decrease in Googles usage rate in China this past year.
Baidu also faces competition from Chinese companies, such as Sohu, Netease and Tencent.
These companies also provide search engines. While the user base for these search engines is
less than Baidu, each company has a stable user base and web traffic. Baidu competes directly
with these competitors for user traffic and online advertising. Additionally, Baidu competes with
other B2B service providers such as Alibaba.
The PRC government extensively regulates the telecommunications and Internet industries. This
is illustrated by the recent difficulties Google has encountered in its Chinese operations. The
State Council and the Ministry of Industry and Information Technology (MIIT) are both highly
involved in regulation. In fact, Baidu only has contractual control over its websites rather than
owning them. This is due to a restriction on foreign investment providing value-added
telecommunication services in China.10 To minimize this risk and comply with the regulations,
the company operates its websites through Chinese based affiliated entities: Baidu Netcom and
Beijing Perusal. In the future, new laws and regulations may be enacted that regulate Internet
activities, including advertising and online payment. If such laws were enacted, they would
8
Ming Zhao, C. and Nan Li. 3Q Earnings Recap; Raising Target to $125. Chinese Internet and New
Media-SIG Susquehanna. October 22, 2010. Print.
9
Baidu, Inc. 2009 Form 20-F. Retrieved from
[Link]
10
Ibid.
impact Baidus current operations. Additionally, Baidu also operates with some uncertainty
concerning licensing practices, in which licenses and permits may be subject to challenge. If
Baidu were not able to renew licenses and permits from the government, current business
operations would be very adversely affected.
Ultimately, Baidu has adapted to the conditions of the Chinese market, which allowed the
company to grow rapidly and take over the market in China. There are obstacles to working in
China, such as government censorship and slower Internet load times, but companies need to
be patient and adaptable.11 Baidus adaptability may be viewed as a competitive advantage as
the company has been able to develop successfully in a difficult environment.
Comparison to Google:
An analysis of Baidu is not complete without reference to Google, the leading search engine
provider in the world. At first glance both companies seem highly similar; even the respective
websites are remarkably similar. Both companies derive revenues from advertising; Baidu is
implementing the model that has worked so well for Google. However, Baidu did not set out to
mimic Google, but rather imitated Inktomi, a company acquired by Yahoo.12 The initial idea was
to power search on other Web portals.13 The company eventually launched its own website,
which was the beginning of Baidu.
Both Google and Baidu offer many of the same services (i.e. News, Stocks, Weather, IM, etc.)
and derive revenues in the same way. However, the companies are quite different in other
aspects. Baidu seems to have a much stronger portfolio of consumer facing products. Baidu has
an extensive network of consumer-side services from Youa (a service similar to eBay) to
BaiduPay (a service similar to Paypal). Additionally, Baidu allows users to download MP3 songs.
This is a unique strength for the company and has helped fuel remarkable.
Google has a much larger presence in the mobile phone market than Baidu. While Baidu is not
expected to have an operating system anytime soon, the company has partnered with phone
services to provide mobile search capabilities.
Additionally, while the presentation of Google and Baidu search results appear similar, there are
significant differences. These arise from differences in the scanning habits between North
American and Chinese Internet Users.
11
Ha. Anthony. Baidu CEO: We tried harder than Google in China. Venture Beat. Nov. 15, 2010.
[Link]
12
Einhorn, Bruce and Brad Stone. "How Baidu Won China - BusinessWeek." BusinessWeek - Business
News, Stock Market & Financial Advice. 11 Nov. 2010. Web. 30 Nov. 2010.
<[Link]
13
ibid.
Figure 514
The images in figure 5 are heat maps of the scanning patterns of different Internet users. Both
web pages are from Google. The page on the left illustrates the scanning patterns of North
American Internet users while the image on the right displays Chinese users. North American
users are concentrated on the top left corner and according the research usually focus on the
top three or four search results. Chinese users scan through out the whole page. This comes
from a slight distrust of the top results.
Figure 615
Figure 6 illustrates the difference between the scanning patterns of Baidu users and Google
users. Baidu users scan through the whole page and even spend more time with each page view.
14
"Chinese Eye Tracking Study: Baidu Vs Google." Search Engine Land: Must Read News About Search
Marketing & Search Engines. Web. 30 Nov. 2010. <[Link]
15
ibid.
Baidus search results are catered to the scanning habits of Chinese users. This has helped the
company succeed in the Chinese market. Additionally, Baidus suggestive search terms are also
much more helpful specifically for Chinese users. Phonetic characters are incredibly difficult and
time consuming to type. Baidu provides suggest terms for phonetic Chinese language at the
bottom of the page to further assist users. So while there are many similarities between the two
companies, there are also significant differences.
SWOT Analysis:
Strengths:
Weaknesses:
Operational Efficiency
Strong Liquidity
Strong and Diversified Customer Base
Comprehensive Produces and Services
Portfolio
Concentrated Geographical Operations
Losses from Currency Translation
Dependence on Baidu Union
SWOT Analysis:
Threats:
Opportunities:
Invalid Clicks
Declining Returns
Rapid Technological Changes
Highly Competitive Market
Growth of Communications Industry
Strategic Alliances
Positive Outlook for IT Services
Figure 716
Strengths: Baidu has a number of strengths that contribute to long-term success. The company
has high operational efficiency; the operating margin increased 1.79% in 2009 to 36.08%. Figure
6 illustrates Baidus recent growth in its operating margin, which is much higher than the S&P
average of 7.26%. Baidu has generated an increase in its net profit margin. The company has
also decreased operating cost and administrative cost as a percentage of sales.
16
Global Company Intelligence. Financial and Strategic Analysis Review. October 2010. p 15. Print.
Figure 8
Baidu also maintains strong liquidity. The company has a current ratio of 3.46 compared to the
S&P average of 1.46. In 2009, net cash from operations was CNY2,279.43 million and net
working capital growth was 71.89%. Baidu currently does not finance operations with debt. Due
to the amount of cash generated by operations, the company does not need to use debt to
finance any operations.
Baidu has a strong and diversified customer base, which ensures favorable top line
performance. Customers include small and medium enterprises, large domestic corporations
and also Chinese divisions of multinational corporations. Customers span a variety of industries
including education, franchising, electronic entertainment, and financial services. In 2009, online
marketing customers increased 11.62%. In addition to a growing customer base, Baidus
revenue per customer also increased between 2008 and 2009 from CNY11,200 to CNY14,000.
Finally, Baidu offers a comprehensive portfolio of products and services allowing users and
customers to obtain products and services from a single company. Baidu is able to leverage the
demand for specific products in its portfolio into sales for other products. As a one-stop shop,
Baidu is able to grow business and enhance financial performance.
Weaknesses: Baidu is geographically located in China and Japan. In one aspect, this geographic
limitation is a weakness given that it naturally limits the market size. However, this physical
concentration can also be seen as a strength. As mentioned above, Google has been severely
limited in its Chinese operations, allowing Baidu to capitalize on the growing Chinese market.
The expectation is that after saturating the Chinese and Japanese markets, Baidu will expand
into other international markets.
Another weakness is that Baidu faces losses arising from currency translation. The Chinese
currency has recently been highlighted in the news, as the PRC government effectively kept the
currency devalued. Additionally, the dollar has been weakening. The companys functional
currency is USD, but the companys reporting currency is CNY. In 2009, the Japanese Yen (JPY)
depreciated against the CNY by 2.4%, which resulted in a loss when net assets were translated
from JPY to CNY. In 2009, this loss amounted to CNY3.96 million, down from CNY27.6 million in
2008 and CNY48.26 million in 2007.
Finally, Baidu depends on the Baidu Union to generate a significant amount of revenue. Revenue
is generated by users clicking on links that are displayed on Baidu Union members property.
The revenue is split between Baidu and the Union member. If Baidu is unable to add new
members, it may not be able to continue its rapid growth rate. Additionally, competitors may
offer Union members better rates requiring Baidu to spend additional revenues to maintain
member numbers.
Threats: The first threat for Baidu comes from invalid clicks. Invalid clicks occur when the
number of clicks are artificially inflated. Since revenue is generated from advertisers on a per
click basis, fraudulent clicks could expose the company to variety of risks. It possible that Baidu
might be subject to refund revenues or even be subject to a lawsuit. These types of events could
potentially weaken brand image.
Baidu competes in an industry characterized by rapid technological changes. Company
technology may quickly become obsolete. The failure to innovate new products and pioneer
new markets will severely impact the future performance of the company. Additionally,
competitors may develop and release new products that eclipse Baidus product offering.
Figure 9
Baidu experienced a decrease in return on equity and assets in 2009 (Figure 7). While only a very
recent finding, this is a concern if the pattern continues. It may indicate that Baidus
management is not effectively utilizing company resources. Despite the decline, return on
equity and return on assets are both higher than the industry and sector average.
Finally, Baidu faces a threat from operating in a highly competitive market. Google and
Microsoft are both large companies with more financial resources. These companies have been
operating longer, have greater brand recognition, and have established consumer and supplier
relationships. Baidu must also compete with alternative forms of advertising as customers may
choose to spend advertising dollars on magazine, newspaper, television or radio
advertisements.
Opportunities: Baidu has many positive opportunities in the future, since the communications
industry in which the company operates is growing. The industry is expected to reach USD 597.1
billion by the end of 2011 and grow at a rate of 3.5% annually. Future demand for
communications infrastructure is expected, presenting opportunities for Baidu to expand its
products and increase its customer base.
IT services also has a positive long-term outlook. IT spending is expected to make a complete
recovery by 2012 and subsequently grow at a rate of 6% to reach USD3.4 trillion in 2010.17
Specifically, green IT services are expected to fuel a growth of 30% over the next few years.18
Hardware, software, and services are key growth segments and areas in which Baidu can
experience dynamic future growth.
In addition to growth in the above industries, the Chinese market is rapidly growing, providing
Baidu with a larger market. Expansion in Japan is also at an early stage, with additional market
share growth available. Baidu is expanding into other user-facing services, including a
partnership integrating its technology with mobile devices.
Baidu has effectively engaged in strategic partnerships. In 2010, Baidu entered into a joint
venture with Rakuten, forming Chinas largest B2B2C online shopping mall for Chinese Internet
users. The joint venture requires both companies to invest $50 million USD over the next three
years. This is the second partnership in the past three years for Baidu. In 2008, a partnership
was formed with China Netcom Group (CNC) to offer a search page for CNC users, which
allowed Baidu to increase its customer base.
Outlook:
The outlook for Baidu is very positive. The company competes in a growing Internet service
industry expected to continue expanding over the next five years. Moreover, Baidu operates in
China, the fastest growing major economy in the world. Internet usage in China is currently
much lower than the United States, but is increasing rapidly, providing ample growth for the
market. Moreover, the Chinese government has made it very difficult for international
companies such as Google to operate in the Chinese market. As a result of governmental
influence, Baidu has an edge over international competitors. Domestic competitors have not
been able to generate the same success as Baidu, who has utilized their advantage and now
holds over 76% of the search engine market.
Baidu has invested significantly in research and development activities. These investments have
led to breakthrough products, such as Phoenix Nest. The company has developed its web search
engine to return relevant topics quickly and easily for users. Additionally, the company has
expanded into Japan. While Japan is a mature market and the expansion there by Baidu is still
new, there are promising signs for that new market. Successful performance in Japan may be an
indicator that Baidu will be able to enter other country-centered markets. Processes and
strategies learned in the successful entrance to the Japanese market may be leveraged into new
markets.
The company has also used strategic partnerships to foster growth. Additional partnerships and
acquisitions are expected to fuel company growth and augment the high organic growth. The
17
18
Global Intelligence Company. Financial and Strategic Analysis Review. October 2010. p 16. Print.
Ibid.
future outlook for company growth in both short and long term is very positive, with a number
of catalysts that can help fuel that growth.
QUANTITATIVE ANALYSIS
Financial Analysis:
Baidu competes directly with Sohu, Google, and Microsoft among other companies. Figure 8
illustrates the financial performance of Baidu relative to those companies. Baidu has achieved a
faster sales and EPS growth rate than both companies. The P/E ratio as well as other valuation
ratios (P/S, P/book, P/CF) are all higher for Baidu. The high valuation ratios are expected since
Baidu is growing rapidly and continued high growth is expected. As the company matures, these
ratios will decrease to levels in line with the industry average. Each of the individual companies
in the figure have chosen not to use debt in financing operations. This means that debt to equity
ratios for each company is zero. Due to a strong cash position, it unlikely that Baidu would use
debt in its capital structure in the short-term future. Baidu has been able to achieve a gross
margin higher than Google and the industry average. While Sohu has a larger gross margin, this
may be related the size of Sohu as a small cap company. Additionally, Baidu has very strong
management ratios. Return on assets is twice that of Google and Sohu, as is ROI and ROE.
Figure 10
From the chart above, it is obvious that Baidu has had strong past performance. While past
performance is not a clear indication of future results, Baidus past results combined with the
companys qualitative characteristics indicate that Baidu will likely continue strong performance
in the future. Figure 9 graphically displays the price performance of Baidu stock compared to
both Google and Sohu. Googles price performance line is represented by the dark brown line,
which equates to roughly 0% change. Sohus performance is displayed by the light brown line
and equates to about 25% growth. Finally, Baidus performance is illustrated by the blue line
and equates to over 150% increase in 2010.
Figure 1119
Other search engine providers have similar price performance to Google. Microsoft has had
negative performance, while Yahoo and AOL have been marginally positive. With the positive
future forecast for the Internet communications, especially in China, there is good reason to
believe this performance will continue in the immediate future.
Discounted Cash Flow Valuation:
A discounted cash flow valuation was performed on Baidu as a company. The price per share
was determined to be $126.73. This price is approximately $20 more than the current stock
price and represents a 20% price increase.
In calculating this price, the cost of capital was calculated to be 12.66%. In the case of Baidu, the
weighted average cost of capital (WACC) is equal to the cost of equity since the company uses
no debt in its capital structure. The cost of equity was calculated using the capital asset pricing
model (CAPM). A beta of 1.8 was used to represent the riskiness of the company. Baidu is a
large company, with strong liquidity and a large amount of cash. However, I chose the highest
beta estimate, which was from Standard & Poors. Baidu operates in a risky technology sub
industry. Additionally, operating primarily in China increases the risk of the company as
governmental regulations may change and negatively affect the company. The risk-free rate of
4.02% is the rate for a long-term treasury and was agreed upon by the class. The market risk
premium was decided to be 4.8% by the class. This represents the geometric average of stock
market returns from 1928-2009.
19
Chart retrieved from [Link]
Figure 12
I forecasted cash flows for fourteen years beginning in 2010. I divided those years into three
periods: high growth (2010-2011), intermediate growth (2012-2014), and declining growth
(2015-2023). In 2010, the growth rate is assumed to be 80%. Currently, Baidus performance is
matching that estimate.20 In 2011, a growth rate of 74% was used. This number was derived
from a consensus of analyst reports gathered from InvestText, through the PSU library. During
the intermediate growth rate period, I reduced the growth rate to 60%, 50%, and 45%
respectively. While most analyst reports that I followed did not complete a forecast growth this
far in the future, I believe this to be an achievable growth rate for Baidu. The Chinese market is
still expanding. With the Chinese Internet saturation currently at 29% and growing rapidly, there
is still a high growth potential for Baidu within China alone. The increase of the products,
strategic alliances and expansion into Japan all contribute to this high growth rate. Additionally,
average revenue per customer is increasing. In the third quarter of this year it was up 10.2%
quarter-over-quarter and 40.3% year-over-year.21 Ultimately, I believe the market capable of
supporting a high growth rate for the next 5 years. In 2015, I believe that the growth rate will
begin slowing. In projecting cash flows, I had the growth rate decrease at a consistent rate. I
dont believe there will be a huge drop in the growth, especially as the company continues to
expand and innovate new products.
In terms of expenses, I estimated cost of goods (COGS) to be roughly 35% of sales. Baidu has
been currently able to achieve high margins. I also forecasted that COGS would increase slightly
as the company matured. This increase also captures inflationary pressures, which increase the
cost of developing and providing products and services. Selling, General, and Administrative
(SG&A) expenses were forecasted at 12% of sales. This is slightly higher than the current rate of
11%. The company has had to expand the workforce at a rapid rate and the I tried to capture
any inefficiencies in the company in that assumption. I also forecasted that SG&A expenses
20
21
Wei, Dick. Asia Pacific Equity Research: [Link]. J.P. Morgan. October 22, 2010. Print.
Ibid.
would gradually increase over the 14 year projection. This was to capture inflation in the SG&A
expenses as well as account for additional inefficiencies that the company may develop as it
matures. Finally, the cost of research & development (R&D) was initially projected as 11% of
revenues during the high growth period. During the intermediate growth period, I lowered the
percentage to 10%. Finally, I decreased the R&D to 5% by the end of the period. This was to
account for a more realistic view of expenditures. According to my forecast, by the end of 2024,
Baidu will be spending $2 billion on R&D if the percentage is dropped. Figure 13 displays the
projected cash flows according the assumptions made in the DCF. A larger version can be found
in the attached DCF spreadsheet.
Figure 13
After calculating the cash flows, the terminal value was calculated using the perpetuity growth
model and assuming a growth rate of 4%. The intermediate cash flows and terminal value are
discounted at the cost capital to arrive at the equity value. The equity value is divided by the
number of shares outstanding to arrive at the value per share of $126.73. This value is in line
with the consensus of analysts following the stock. Yahoo Finances states that the median
analyst values Baidu at $120 per share. Standard & Poors is at the high end of the spectrum and
listed the fair market value at $140.22
Figure 14
Relative Valuation:
In constructing the DCF valuation, I realize that I assumed a high growth rate for 5 years
decreasing consistently to a terminal growth of 4%. As such a growth rate is hard to maintain, I
decided to reinforce my valuation using a multiple approach. Dividing the current price by the
expected earnings in 2011 yielded a forward P/E ratio of 46.3.23 The 2011 EPS estimate of $2.72
was multiplied by the forward P/E, resulting in a valuation of $125.94. The EPS estimate is
sourced from [Link] and is within the range of $2.4 and $2.89.
22
23
Kessler, Scott. Stock Report. Standard & Poors. November 13, 2010. Print.
Wei, Dick. Asia Pacific Equity Research: [Link]. J.P. Morgan. October 22, 2010. Print.
The result of the relative valuation is a stock price that is in agreement with the results of the
DCF I performed on the stock. I believe the fair value of the stock to be in around $125-$127.
However, I will assert the DCF result for a target price for a Baidu purchase.
Summary:
Baidu is a growth company with many positive prospects in the immediate future. The company
has strong R&D endeavors that have generated strong returns and organic growth. Phoenix Nest
is a relatively new marketing platform; revenues generated through this platform are expected
to grow particularly over the next few years. Baidu has effectively used strategic partnerships
and acquisitions to open new markets and fuel further growth. The development of the largest
B2B2C online shopping mall in China is very promising. The performance of the joint venture will
become more readily apparent as the project develops in the next couple years. Additionally,
the expansion into Japan will also begin to return depending on the success of market
penetration by Baidu. Initial indications are strongly positive that Baidu will be able to generate
significant revenue. Finally, the markets in which Baidu currently operates are also expected to
grow for the next few years, presenting Baidu with further opportunities.
Baidu faces some risks from operating in a single geographic region. However, the company has
strong ties with the Chinese government, allowing Baidu to take advantage of a key
demographic in which Internet usage is rapidly growing. Successfully entering the Japanese
market may also indicate that Baidu will be expanding into additional geographic markets in the
immediate future.
Quantitatively, Baidu is performing very well financially compared to competitors and to the
industry at large. The company does not use debt in its capital structure and has strong liquidity.
The large cash position allows Baidu to move quickly and respond to changing market
conditions. Management ratios (ROA, ROE, and ROI) indicate successful utilization of resources
as well as very desirable returns. The DCF of Baidu indicated that the company is undervalued by
about 20%. The fair value is about 126.73, implying significant growth in value in the next 12
months. Additionally, multiple analysts support this value. Yahoo Finance states the median
price opinion is $120 and Standard and Poors analysis valued Baidu at $140.24 Based on both
qualitative and quantitative factors, I recommend the purchase of 40 shares of Baidu for the
CFASP portfolio.
24
Kessler, Scott. Stock Report. Standard & Poors. November 13, 2010. Print.
Appendix
Income Statements
Balance Sheet
Cash Flow
FCFF and FCFE Calculations
**Forecast of Free Cashflows available on Discounted Cash Flow Spreadsheet
Weighted Average Cost of Capital
Valuation