Is Search Market Share a Serious Concern for Baidu, Inc?

Can Baidu weather the storm of rising competition and a declining market share?

Jul 8, 2014 at 6:00PM

Baidu (NASDAQ:BIDU) is a short-term favorite of analysts and investors alike. However, should rising PC and mobile search competition from the likes of Alibaba and Qihoo 360 Technology (NYSE:QIHU), combined with the prospects of emerging threats like Cheetah Mobile (NYSE:CMCM), leave investors concerned long term? Or, will Baidu's strong monetization practices take the stock even higher?

Looking good for the meantime
Deutsche Bank
is the latest in a string of research firms to speak highly of Baidu in recent months, notably ahead of its second-quarter earnings report. Deutsche notes that it expects Baidu to report revenue of $1.93 billion in the second quarter, slightly above the consensus and representing year-over-year growth of 59%.

Baidu's mobile search business has grown rapidly, with 160 million daily users and stabilization of its advertising prices on a per-click basis. Analysts estimate that Baidu controls approximately 73% of the combined PC/mobile search business in China. This, combined with the natural growth of the Chinese market, has caused shares of the company to double over the last year.

What about PC Internet search market share?
With that said, analysts are clearly fans of Baidu, including Deutsche Bank, Pac Crest, and Stifel, just to name a few in recent months. However, at 37 times earnings, Baidu is not cheap. Also, with selling, general, and administrative expenses rising nearly 140% in its last quarter, the company has some cost management issues as well.

Yet, Baidu's most significant challenge is rising competition. Most notably, Qihoo 360 is quickly on its heels in the PC search market, and this should scare long-term investors who look beyond the second quarter.

Qihoo 360 is most known for its security applications on both PCs and mobile. The company has approximately 479 million PC users and its mobile security application, Mobile Safe, has a whopping 538 million users.

This enormous presence led Qihoo 360 to the Internet search business, where margins are high and monetization practices are very similar to the Chinese security application industry. Albeit, Qihoo 360 Search was launched and already controls 25% of the market by search volume, up sharply from 23% in the fourth quarter of last year and 20% in early 2013.

Qihoo's rise in search corresponds with a decline for Baidu, whose PC share of 58% is sharply lower than the 80% it once owned in years past. During Qihoo's last quarter it finally started to show signs of Internet search monetization, which given Baidu's $5.7 billion in 12-month revenue, could bode well for Qihoo. However, given Qihoo's rapid rise and the fact that it's now creating revenue from search, keeping per-click prices high might pose a challenge for Baidu.

Baidu mobile might not stay a catalyst for long
Due to the rise of Qihoo in PC search, among other less significant threats, Baidu had to innovate, and did so with its mobile search platform. This product was specifically cited by Deutsche in its report, as competition wasn't considered damaging.

However, Alibaba recently purchased a large stake in mobile search vendor UCWebb, who claims to have a 20% market share in mobile search. Also to no surprise, Qihoo launched a mobile search application last month, which given the success of its PC browser, could mean more trouble for Baidu.

Finally, there is the risk of emerging companies with large networks entering the space. One example is Qihoo competitor Cheetah Mobile, the No. 2 Internet security software provider in China. Cheetah Mobile clearly focuses on mobile and is rapidly growing in this space.

In its last quarter, it had 222.5 million total monthly active users, a near 34% increase over the prior quarter, with its Clean Master application accounting for over 150 million users. With the company deriving much of its revenue from third-party user referrals in the search segment, it would make a lot of sense for the company to create such an application and follow in Qihoo's footsteps.

Foolish thoughts
Analysts and investors might like Baidu's short-term prospects, but the long-term outlook is anything but reassuring. Albeit, Baidu is still king when it comes to search engine market share by revenue, with an 81.7% share according to iresearchchina.com

As new competitors steal search market share via users and volume, and offer cheaper advertising and marketing products, Baidu's cost-per-click will likely fall (or be pressured at a more significant rate). Overall, this conclusion doesn't bode well for margins or the Baidu faithful.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Baidu. The Motley Fool owns shares of Baidu. 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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