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A week ago I was wondering whether Baidu (NASDAQ: BIDU ) had bottomed out after hitting a fresh two-year low earlier this month. Well, China's leading search engine has gone on to close higher in six of the past seven trading days, posting better than a 10% bounce in that time.
Baidu is still far away from its all-time high of $165.96 set two summers ago. It's no longer the market darling that it used to be. Analysts have been gradually lowering their 2013 profit targets, and that's a stark contrast to when Wall Street had to chase the company's forecasts higher. There's a smaller player nibbling at its dominant market share.
China's economy has slowed, but there was some welcome news on that front on Friday. HSBC's preliminary manufacturing purchasing managers' index rose to a 14-month high, suggesting that the country's aggressive approach to getting its economy rolling again may be working.
It's against this backdrop that Baidu faces a challenging year ahead, but I'm armed with a crystal ball and a few predictions. Let's dive right in.
1. Baidu will close above $116.47.
Despite a head-turning rally in recent days, the dot-com laggard is still trading in the double digits. It's unlikely to close out 2012 in the black, and this will be only its second losing year since going public in 2005. The Chinese speedster's first down year was 2008, when the stock surrendered more than two-thirds of its value. The plunge was so brutal that even a 239% surge in 2009 still left the shares trading for less than where they were two years earlier.
I don't see that happening this time. Baidu will close out 2013 trading higher than the $116.47 where it finished at the end of 2011. The stock won't need to more than triple to get there, and that helps.
Baidu is just too cheap right now. The stock is trading for just 17 times next year's earnings, and even the jaded analysts see the company growing its revenue and net income by 36% and 27%, respectively, next year. Baidu is also fetching just 13 times Wall Street's profit target for 2014, and that's important because that will be the forward earnings multiple at the end of next year.
2. Qihoo 360's threat will ease.
It's hard to believe that so much of Baidu's downfall in recent months comes from the simple move of Qihoo 360's (UNKNOWN: QIHU.DL ) rollout of a rival search engine this summer. Baidu has lost more in market cap in that time than the entire value of Qihoo 360!
So yes, Qihoo 360 has made a strong first impression, but amassing 10% to 15% of the market is only a sliver of Baidu's dominant position. How will Qihoo 360 hold up as it monetizes search? Will the quality hold up?
When Baidu battled Google (NASDAQ: GOOGL ) certainly a quality rival, the market share came mostly at the expense of smaller players. Even at its peak, Google had roughly half of Baidu's market share. Does anyone really think a somewhat controversial company with a popular Internet browser and suite of security software will unseat Baidu?
Strategically speaking, investors may want to buy both Baidu and Qihoo 360, canvassing China's booming search market at a time when the world's most populous nation is migrating online. Even if Qihoo 360 proves to be a flash in the search pan, it's growing too quickly in its online specialties to ignore as an investment.
However, when it comes to its threat to Baidu specifically, expect Baidu to win out. Baidu has been at it for too long. Baidu also isn't the kind of market leader that lets pride get in the way. When it saw that Google was doing a few things better in terms of search, Baidu quickly rolled out Phoenix Nest to emulate Google's globally successful and ethically superior model.
3. Baidu will buy its way back into favor
Baidu had nearly $3.4 billion in cash and short-term investments as of the end of September, and its high-margin business continues to print money. On the other hand, you have a company that spooked investors two months ago with its uninspiring guidance.
Baidu needs to start tapping its capital. Whether it engages in aggressive share buybacks or picks up the pace of its acquisitions, Baidu needs to awaken its dormant vault and put it to good use.
As acquisitions go, Youku.com (UNKNOWN: YOKU.DL ) provides an example. It was China's top video website, but the smaller Tudou was making waves. Tudou struck a partnership with SINA's (NASDAQ: SINA ) Weibo -- the top microblogging site often referred to as the Twitter of China -- to make it easier for SINA users to share videos through Tudou. It was the beginning of a threat to Youku's market leadership, and Youku reacted swiftly by acquiring Tudou a few months later.
This would be a sound game plan for Baidu. Acquire Qihoo 360, and the threat goes away. Baidu would also pick up niche leadership in Web browsers and online security software.
Now, I won't go out on too far of a limb here. The chances Baidu will snap up Qihoo 360 are slim. However, Baidu needs to start thinking about areas in mobile and other Internet growth markets where it may be easier to cut a big check than to come up with an in-house solution. Baidu has made nibbles in the past to access promising areas including online travel, but now it needs to be more aggressive.
It will be. There's too much at stake.
Betting on China
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