Now's the Time to Buy Baidu

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The bottom line is I'm going to be adding some Baidu (Nasdaq: BIDU  ) to the real-money portfolio I manage on Fool.com. The company was down nearly 14% last week, thanks to the introduction of a search engine from Qihoo 360 (Nasdaq: QIHU  ) .

In the end, while Qihoo presents another competitor to Baidu, its potential to disrupt Baidu's business isn't in line with the recent sell-off. I'll be taking the opportunity to add a small position in Baidu with an eye to more buys in the future if the company's shares keep falling.

The backstory
If you're wondering how a company like Qihoo 360 could cause so much damage to the share price of a search giant like Baidu, we have to look back at what the company is and how it's come to be such a disruption in the Chinese Internet space.

Qihoo 360 started out as an antivirus company, but it changed direction to focus on higher-revenue opportunities. In 2008, it formally launched its own Web browser, which grew in popularity by piggybacking on Qihoo's antivirus software that suggested its installation. With a browser in place, Qihoo was able to redirect traffic to its default landing page, hao360, which generated revenue predominantly through advertising and a search agreement with Google (Nasdaq: GOOG  ) .

However, as you'll note from clicking on hao360, a link-out portal like the one Qihoo currently operates has limited potential. Far more appealing is an area like taking the search bar over. Rival Sohu (Nasdaq: SOHU  ) used its Sogou Explorer as a launching point for its search services. That effort is proving fruitful as Sogou search continues to grow at triple-digit rates -- 122% sales growth last quarter alone.

Qihoo, more than meets the eye?
Qihoo's browser market share is much higher than Sogou's, which shows the company's potential. Yet the rub in all this is that finding out exactly how much market share Qihoo's 360 browser has is up for debate. The company has its fair share of detractors -- both with its business practices and allegations that it falsifies financial information and business metrics.

With regard to business metrics, several notable research agencies and financial bloggers have taken aim at Qihoo's reporting of, well, just about every measure it publishes. For the sake of how Qihoo's search entry affects Baidu, though, let's stick with a look limited to Qihoo's browser strength. Last November, after a dust-up when the company claimed 57% market penetration, leading many media outlets to report Qihoo as the leading search engine, the company's CFO clarified that the company maintained a 37% market share.

Verifying that with Baidu's own published data, we find Qihoo's 360 browser at about 22% market share and not gaining huge amounts of momentum. Naturally, visits to Baidu might be lower from Qihoo's browser, as many users would use the default search, which had previously been Google. So, as a third source, we find CNZZ currently reports Qihoo at 27% browser share.

A real threat from Qihoo?
Adding it all up, let's say it's likely Qihoo's browser market share is somewhere in the high 20s. That's obviously a threat to Baidu, as the company currently controls search-market share that's routinely reported at 75%-80% in the country. If all Qihoo 360 browser users suddenly switched to becoming dedicated users of its default search, that'd be a blow to Baidu. That fear isn't without precedence, either; figures from firm iResearch indicate that the growth of Sogou's search engine is directly in line with its browser, where Sogou search is default. As the former president of Google China, Kai-Fu Lee, put it, "Chinese users have a habit of entering search queries to a browser."

With multiple reports showing Qihoo went from zero market share to more than 10% in a week, investors seem to have accepted that Qihoo will be a major threat to Baidu. I think this is an overreaction for a few main reasons.

  1. Qihoo's gain not necessarily Baidu's loss: Remember that Baidu wasn't the previous default search engine on Qihoo's browser; that spot belonged to Google. While Baidu has shown some preliminary share loss, it's really Google that has the most to lose, with Qihoo moving its own search into the default position.
  2. Inferior technology: Early rumblings suggest that Baidu is weighing legal action against Qihoo for the similarities between Qihoo's search engine and its own. That data was corroborated by Sogou, which noted that Qihoo's 360 search shares a far higher similarity to Baidu than other competitors. The bottom line is that Qihoo's technology won't be anywhere near Baidu soon, though it may "borrow" portions of it.
  3. Shiny new toy: Some preliminary estimates of Qihoo's market share may have it slightly cresting 10%, but remember that as with any product launch, users will initially want to try a new product. Whether or not searchers will stick with 360 search in the coming years after testing it out is a much more difficult proposition. I'll wait until a bit further down the road before buying into Qihoo’s search market share.

Zooming out
While I've taken a deeper look at the dynamics of Qihoo's entering the Chinese search market, as I led off by saying, the bigger picture is that I intend to purchase shares of Baidu tomorrow in the real-money portfolio I run on Fool.com. To address the longer-term opportunity with Baidu itself, I'll be following up with another article on the company and why its stock is an attractive value later in the week. If you'd like to catch that article, I'd suggest subscribing to my Twitter feed, as I'll update it with further analysis on Baidu and future buy recommendations.

In any event, I plan to start with a small purchase of Baidu tomorrow -- just five shares. However, I'm keeping it on a close watchlist so that I can buy more shares if it sells off again either from any more worrying about threats from Qihoo or general market plunges. Also, if you're a Baidu investor or just looking for a more in-depth look at the company, we've recently completed a premium research report on the company. It not only gives a full write-up on Baidu, but it also comes with continuing updates through the year. Get started now.

Eric Bleeker owns shares of Baidu. In addition, his real-money portfolio on Fool.com owns Google. The Motley Fool owns shares of Baidu.com. Motley Fool newsletter services have recommended buying shares of Sohu.com, Baidu.com, and Google. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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