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Baidu's Management Explains Its Long-Term Approach

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Baidu (NASDAQ: BIDU  ) released its fourth-quarter earnings on Wednesday, beating analyst estimates on the top line, but missing on the bottom, as profits fell slightly year over year. The company, which is often called the Google (NASDAQ: GOOGL  ) of China, made it clear on the conference call that it has a long-term outlook. Baidu is investing heavily to fend off competition from the likes of Qihoo 360 (NYSE: QIHU  ) and create additional revenue streams.

What exactly is Baidu investing in?
CFO Jennifer Li warned that 2014, like the year prior, will not see very much profit growth. Instead, the company will continue investing in revenue growth. Specifically, she mentioned the company plans to increase spending on "channel and marketing, infrastructure, content, and traffic acquisition cost."

Additionally, CEO Robin Li outlined the company's interest in growing outside of search:

In addition to search, we are now also strategically focused on the following four areas: one, mobile and cloud; two, location-based services; three, consumer products -- including gaming, music, online literature, and social; four, international operations. We also have invested in entities that are very strong in their respective industries of online travel and online video.

These areas present strong growth opportunities for Baidu but will require additional spending to build products, monetize, and grow its audience on each platform. Baidu is spending heavily on mobile. It acquired the 91 Wireless app store last year, and now controls 41% of app distribution in China. Additionally, the company has partnered with several OEMs to pre-install its search app, and it recently joined the Tizen Association. Mobile contributed 20% of revenue in the fourth quarter, an increase from 10% of revenue in the second quarter.

Its biggest competitor in the space is Qihoo 360, which operates the second-largest search engine in the country and is rapidly growing. The company has successfully leveraged its PC security software to become a staple in mobile. Its mobile security software is used by more than 400 million smartphone users as of the third quarter. Baidu, comparatively, just saw its search app reach 400 million users in the fourth quarter.

Baidu's long-term approach
Co-Founder, Chairman, and CEO Robin Li put his company's lack of profit growth in the near term into perspective on Wednesday. In the short term, as Baidu focuses on growing revenue and fending off competition, its margins will decline. In the long term, however, Li expects Baidu will post margins comparable with other Internet companies.

When you talk about long term, let's not just focus on this year. Maybe in several years -- three, five years down the road -- when you look at our revenue scale, we expect the margin level to be similar to other Internet companies at that kind of revenue level.

Operating margin declined nearly 15 percentage points in 2013 from 2012, and Baidu's forecast for no profit growth implies further declines of 10 to 12 percentage points, according to Jiong Shao of Macquarie Research. This would put it in line with Google, which reported an operating margin of 23.3% in 2013. Considering that Baidu isn't shy about borrowing from Google's playbook -- it also made investments in video, mobile, location, music, social, etc. -- it makes sense that its margins would end up becoming similar.

That means we may see profit again growing along with revenue as soon as 2015. But the company may see its operating margin dip below that threshold first, as it continues to focus on growth.

Staying smart and aggressive
Baidu's management is more concerned about expanding the business than making a profit right now. In the long run, Baidu's setting itself up for a lot of revenue growth by investing in different verticals. As operating margin stabilizes in the next few years, that revenue growth will translate into further profits for investors.

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Adam Levy

Adam has been writing for The Motley Fool since 2012 covering consumer goods and technology companies. He spends about as much time thinking about Facebook and Twitter's businesses as he does using their products. For some lighthearted stock commentary and occasional St. Louis Cardinal mania

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9/3/2015 4:00 PM
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