Fellow Fool Morgan Housel and I can't agree on much these days. He was bearish on China last month; I was bullish. Now he's bearish on Baidu (Nasdaq: BIDU ) , and I am bullish on China's top search engine.
I realize I may not be coming from a position of strength. Chinese stocks have dragged global markets low in recent weeks, validating Morgan's bearish stance at my expense.
Still -- let me put up a counterargument to his bearish take on Baidu, and you can decide for yourself.
Born on the Baidu
I'll give Morgan credit for using Google (Nasdaq: GOOG ) as a valuation model to stack up against Baidu. He could have gone for slower players with cheaper valuations, but he went right for the world's top dog in paid search to bring down China's Internet rock star.
He then dug into its first baby steps as a public company, when Google went from earning $0.4 billion in 2004 to $3.1 billion in 2006, a nearly eightfold advance that set the tone for its torrid stock gains.
He points to the $38.7 million Baidu earned last year, suggesting that Baidu is overvalued even if it were able to duplicate that kind of bottom-line catapult.
Let's not kid ourselves. Baidu's earnings won't make that kind of leap in a two-year span. Google was still learning to carve the paid search cash cow in 2004, after launching its AdWords ad network a year before. It was a sandbag of a year that turned into the mother of all trampolines the following year.
Baidu is growing at a healthy clip. It has generated $53.9 million in net income through the first nine months of 2007, already well ahead of the $38.7 million it earned last year. If we go with analyst estimates of $2.30 a share this year and $4.04 a share next year -- and the 34.8 million shares currently outstanding -- Baidu's profits will grow from $38.7 million last year to roughly $141 million next year. Earning 3.6 times what you earned two years ago isn't as glamorous as the 7.8 spurt that Google took from 2004 to 2006, but it's darn impressive.
Besides, there is no doubt about which one is growing faster now. Wall Street expects Google's profits to climb 32% higher next year, and Baidu is looking at a 76% advance. Some analysts, like Citigroup's Jason Brueschke, expect profit growth to accelerate into 2009 after that.
So why are we comparing Baidu to Google at all? The only thing that makes sense is to pit Baidu's 2009-2010 profits to where Google was in 2004, when they were about even in terms of earnings. Three years later, Google is now a $210 billion company. If the assumption is that Baidu follows the market cap trajectory to become an 18-bagger over the next six years, who wouldn't take that in a heartbeat?
Bad news Baidu bears
Valuation concerns are valid with Baidu. I wouldn't call the company "priced for perfection" as Morgan does, although it is certainly vulnerable if it fails to deliver. But you know, cynics said the same thing about Google as it continued to trounce expectations and raise the ceiling on perfection.
When Baidu stock crossed the $300 mark earlier this month, it was trading at just 32 times Brueschke's 2009 profit target. We're somewhat higher now. Every other major analyst isn't as upbeat. We're now just a handful of weeks away from calling 2009 next year. What if Brueschke is right and Baidu is trading at forward earnings discount relative to its growth rate?
So where else is Morgan tossing stones?
"Baidu could lose market share to its competitors," he writes. "Google is not only gaining in the Chinese market but is also striking deals with popular Web portals such as SINA (Nasdaq: SINA ) and CDC's (Nasdaq: CHINA ) China.com."
He's right; but that's half the story. Baidu has also gained market share in the past year. Google isn't growing at Baidu's expense. They are both growing at the expense of everyone else. Oh, and Baidu has also struck ad distribution deals with high-traffic sites like Microsoft (Nasdaq: MSFT ) , China Telecom (NYSE: CHA ) , and China Netcom (NYSE: CN ) . Two can play that game. Baidu is, after all, China's Google with the thickest network of advertisers.
"Baidu has reached a mark of supreme optimism," Morgan writes in conclusion, "a sign that every bit of good news that could come in the future has already shown up in the stock price."
Apparently not, my friend. The stock closed at $301.50 the day before he wrote that. The shares have gone on to inch 22% higher since then.
Dismiss Baidu? Fail to learn the lessons of Google? Go ahead. Just don't start complaining when the bandwagon leaves you behind in a bowl of dust.
Relive the volleys between Rick and Morgan:
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