Shares of Baidu (BIDU -1.78%) tumbled 8% on Aug. 1 following a report that Alphabet's (GOOG 0.56%) (GOOGL 0.69%) Google could reenter China with a censored search engine. Online news publication The Intercept, citing "confidential" documents from an anonymous source at Google, claims that the company will launch a new search engine to "blacklist websites and search terms about human rights, democracy, religion, and peaceful protest."
The project, called "Dragonfly", centers on the development of custom Android search apps -- codenamed "Maotai" and "Longfei" -- which have already been shown to Chinese regulators. The report claims that a final version could be released within "the next six to nine months, pending approval from Chinese officials." Only a few hundred of Google's 88,000 employees reportedly knew about Dragonfly's existence.
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Understanding Google's relationship with China
Google shut down its search engine and other services in mainland China after a widely publicized clash with the Chinese government in 2010. Google had already been in China for four years, and its search engine censored content deemed "sensitive" by government regulators.
However, Google discovered that the government had hacked several Gmail accounts belonging to human rights activists across China. In response, Google shut down its mainland search engine and directed all its mainland traffic to its uncensored Hong Kong site. The Chinese government then shut down Google's remaining services in mainland China.
Google controlled about 41% of China's online search market at the beginning of 2010, according to web analytics provider StatCounter, while Baidu controlled 57% of the market. Google's abrupt exit left the door open for Baidu, which fortified its position as the country's top search engine.
However, other domestic challengers also emerged with their own search engines. Today, Baidu controls about 69% of China's search market. Alibaba's Shenma ranks second with a 20% share, followed by a 5% share for Sogou's engine and a 4% share for Qihoo 360's Haosou. Google lost much its clout in China over the past eight years, so it's doubtful that the company can simply waltz in and win back its abandoned users.
The writing's on the Great Firewall
Yet Google has already been sowing the seeds of its return to China. It retained a smaller advertising business in its offices in Beijing, Shanghai, and Shenzhen, the last of which it's turning into a hub for its hardware operations.
Over the past two years, Google launched its Translate and Files Go apps in China, opened a new AI research lab in Beijing, and tightened its relationship with Tencent through a licensing partnership, an investment in Tencent's e-commerce partner JD.com, and the development of new mini programs for WeChat, the most popular messaging app in China.
Anyone who followed these moves probably would have guessed that Google was gearing up for a return to China's market of nearly 800 million internet users. However, Google's return could face some major PR problems and marketing challenges.
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Google is playing with a double-edged sword
The Intercept's source stated that he (or she) was "against large companies and governments collaborating in the oppression of their people." The source was also worried that "what is done in China will become a template for many other nations."
Amnesty International's Patrick Poon stated to The Intercept that Google's decision to kowtow to the Chinese government would have "very serious implications not just for China, but for all of us" in regards to "internet freedom." Poon warned that the "biggest search engine in the world obeying the censorship in China is a victory for the Chinese government -- it sends a signal that nobody will bother to challenge the censorship any more."
In addition to that PR backlash, Google might need to spend lots of money on R&D and marketing to challenge Baidu again. After Google left China, Baidu expanded its ecosystem with other cloud services, mini programs for its core app, and big investments in AI and driverless cars. Nearly 80% of Baidu's revenue now comes from mobile devices, a market which Google was only starting to crack in 2010.
Therefore, Google might think it has plenty to gain from re-entering the Chinese market, but the damage to its public image and rising operating expenses could cancel out those gains. If it's truly assisting censorship, it can also forget about ever bringing back its "don't be evil" mantra -- which it quietly dropped from its code of conduct earlier this year.
Should Baidu investors worry?
The Intercept's report overshadowed Baidu's impressive second quarter report, which cleared analyst expectations with 32% sales growth and 33% non-GAAP net income growth. Those numbers indicate that Baidu remains the 800-pound gorilla of internet advertising and online searches in China.
As for Google, it seems unlikely that Chinese regulators would welcome it back to China amid escalating trade tensions with the US. Moreover, the Chinese state-owned Securities Times recently declared that The Intercept's report simply wasn't true, citing information from "relevant departments."
Therefore, I think it's unwise for Baidu investors to dump the stock on fears about Google. The report is unconfirmed, and the Chinese search market won't be an easy one for Google to crack after all these years.
