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Is Now the Time to Short Baidu?

Baidu (NASDAQ: BIDU  ) is breaking bears again. China's leading search engine hit new all-time highs in after-hours trading last night after posting another blowout quarter, and it's climbing in morning trading, too. 

The reborn dot-com darling's revenue soared 42.3% to $1.45 billion, just ahead of expectations and at the high end of the guidance it provided three months ago. Earnings rose a mere 1.3%, but that was in line with expectations. Baidu's foray into new areas including video, mobile, and travel have gnawed away at margins. As fast as revenue is growing, bandwidth, content, and SG&A costs are growing even faster. The market's cool with that, obviously. Investors just want to make sure that it's not losing relevance in China since last year's surprising success of Qihoo 360 (UNKNOWN: QIHU.DL  ) in search.

As Qihoo 360 gained traction, the fear was that advertisers would no longer need to lean on Baidu. Well, that certainly hasn't happened. Baidu closed out the period with 464,000 active advertisers, 19% ahead of where it was a year earlier. The average marketing customer is also spending 19% more than it was a year ago. 

The third quarter was encouraging, but it's Baidu's guidance for the current quarter that really has the market rolling. Revenue growth should accelerate this quarter, as Baidu is targeting 45.5% to 49.6% growth for the period. Analysts were betting on decelerating top-line growth.

An interesting side note to all of this is that short interest on Baidu has fallen to its lowest level of the year. There were fewer than 4.7 million shares sold short as of mid-October. Bearish activity peaked four months earlier with 15.6 million shares betting against the company. Yes, we have another case of "short low, cover higher," as Baidu's stock has soared 63% since then.

This isn't the first time that naysayers get it wrong. They tend to flock to shorting opportunities when companies are down on their luck, only to bail when things don't go their way. Logic would tell you that this was going to be a bad strategy here. Baidu may have fallen out of favor earlier this year, but it wasn't going away. It was still posting healthy growth. A few shrewd acquisitions along the way have helped pad Baidu's top-line growth while giving it brighter prospects in mobile.

If shorting Baidu when it was down on its luck was a mistake, does that mean that Baidu is a smart short now that the market's smitten with the Chinese speedster again? No. Baidu may not be as cheap as it was earlier this year, but it still closed yesterday at less than 25 times next year's projected earnings. Set aside the near-term bottom-line growth challenges, and Baidu's premium is more than warranted given its heady top-line growth. 

More than two-thirds of Baidu's shorts have headed for the exits over the past four months, but those are the ones who learned sooner rather than later. Baidu's rolling. You don't want to get in its way.

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9/29/2016 4:00 PM
BIDU $182.23 Down -5.51 -2.93%
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QIHU.DL $0.00 Down +0.00 +0.00%
Qihoo 360 Technolo… CAPS Rating: **