Are Shares of Baidu and Qihoo 360 Priced Right?

There's a lot of upside in both stocks.

May 7, 2014 at 8:30PM

Chinese Internet stocks have taken a beating over the last couple months. Shares of Baidu (NASDAQ:BIDU) and Qihoo 360 (NYSE:QIHU) have fallen about 14% and 30% from their 52-week highs, respectively. At these prices, both stocks appear attractive.

Qihoo, which is well known for its security software for PCs and mobile devices, is trading at a valuation very close to Baidu's. Both are priced slightly higher than Google (NASDAQ:GOOGL), despite much slower growth at the American company.

Look at these numbers

Company

Baidu

Qihoo 360

Google

EPS Growth Q1

23.8%

142.9% (estimate)

4.5%

EPS Growth 2013

3.6%

117%

10.4%

EPS Growth 2014 (estimate)

11.4%

43.1%

21.9%

EPS Growth 2015 (estimate)

39.7%

56.6%

18.3%

Sales Growth Q1

61.2%

107.7% (estimate)

19.1%

Sales Growth 2013

47.4%

104%

19.2%

Sales Growth 2014 (estimate)

50.9%

72.7%

10.5%

P/S (TTM)

9.9

16.4

5.8

P/S (2014 estimate)

7.1

9.4

5.4

PE (2014 estimate)

30.1

34.7

19.8

PE (2015 estimate)

21.6

22.2

16.7

Source: Yahoo! Finance.

Capitalizing on opportunities
Both Qihoo and Baidu are benefiting from strong secular growth in China's Internet population. The number of Internet users in the country climbed 9.6% last year, and the country has an Internet penetration of just 45.8%. Comparatively, the U.S. has an Internet penetration rate of about 80%.

This presents a huge opportunity for both companies to take advantage of, especially with Google bowing out of the market a few years ago. Qihoo, in particular, has a big opportunity in search to capture new users as they purchase new PCs or mobile devices.

Qihoo has tremendous penetration in the security software market. As of the end of 2013, the company's security software was installed on 94.6% of PCs and 467 million mobile devices. This has allowed it to get its browser onto 70% of PCs and millions more mobile devices. The browser then feeds users to its relatively nascent search engine, So.com, which gained 23% of the market in just 18 months.

Qihoo's goal for 2014 is to capture 30% of the search market, but it also needs to start monetizing the platform better. That means spending some of its cash flow on a direct sales force in order to compete with Baidu's sizable team. In the long-run, however, Qihoo's user funnel should help it grow earnings even faster.

Baidu's approach
Baidu has spent heavily to grow its revenue. To that end, it's succeeded quite well. The company has seen accelerating revenue growth in the last three quarters. That revenue growth translated into earnings growth last quarter, validating the strategy.

Baidu's biggest advantage over Qihoo is its ability to spend. Baidu generates more than 10 times as much cash as Qihoo despite its heavy investments in new areas. Baidu has strategically expanded into video, mobile app distribution, maps, payments, and several other verticals in order to drive revenue growth.

Baidu's strategy strongly echoes Google's in more developed markets. But whereas the Internet population is still growing rapidly in China, the market is relatively saturated in most Google-dominated markets. Thus, growth opportunities are far greater for Baidu and Qihoo than Google, as reflected in analysts' estimates. Despite the expected growth, the premiums on Baidu and especially Qihoo seem to fall short of the opportunity.

The price is right
Both Baidu and Qihoo were trading at significantly higher multiples just a few weeks ago. Google shares have seen a similar decline in price to Baidu, but after missing earnings expectations, analysts lowered growth expectations for the year. Comparatively, Baidu has seen an uptick in estimates since its good earnings report.

At these valuations, Baidu and Qihoo present good value for their growth opportunities. Qihoo looks to have more upside as it captures more of Baidu's search share and begins to monetize those users. This could add significant revenue growth on top of its security software and game platforms, which currently generate the bulk of its sales. Currently, it trades for nearly the same price as Baidu on a forward earnings basis.

Don't discount Baidu, however. Its heavy spending has paid off in strong revenue growth, and has already translated into bottom line growth. There's no reason Baidu can't continue this strategy as China's Internet population continues to expand.

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Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Baidu and Google (A shares). The Motley Fool owns shares of Baidu and Google (A shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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