Baidu (Nasdaq: BIDU) is in the crosshairs of this morning's "Heard on the Street" column in The Wall Street Journal.
Like any good bash piece, it begins with the "having said that" accolades to build up China's leading search engine before tearing it down:
- Baidu's stock has risen 40-fold since its 2005 IPO.
- Revenue has grown 25-fold in that time -- and 30-fold for stateside investors given the depreciating greenback relative to the buoyant yuan.
- Revenue is accelerating, pegged to grow at a 78% clip this year after last year's recessionary slowdown of only growing by 39%.
- Taking a page out of Google's (Nasdaq: GOOG) playbook, Baidu is getting advertisers to pay more by expanding the keywords they bid on to generate leads.
- Less than a third of China is online, compared with developed nations hovering around the 80% penetration mark.
- China's economy is growing at a 10% clip, according to World Bank, with Baidu obviously growing considerably faster than that.
Did you enjoy the praise-worthy climb up the roller-coaster chain-lift? I hope so, because here comes the drop.
Hands up!
The article touches on a few potential risks. Rolfe Winkler argues that e-commerce rival Alibaba.com -- where Yahoo! (Nasdaq: YHOO) enjoys a passive minority stake -- could eat away at Baidu's whopping 73% market share through its new search engine fueled by Microsoft's (Nasdaq: MSFT) Bing.
There are also China-related risks.
"Profits are ultimately at the mercy of the Communist Party," Winkler writes. He also alludes to the credit bubble risk.
However, Winkler's longest argument against Baidu is a more practical one. He pits Baidu's $38 billion enterprise value against Google's $170 billion chunk. He assigns a value of $80 billion to Google's stateside operations, because it accounts for a little less than half of its overall business. He then figures that China's economy will be half as large at the United States in four years -- arriving at a value of $40 billion in four years.
Obviously, it's a slow crawl from $38 billion to $40 billion and certainly not the kind of play that someone would want to make given the risks and volatility inherent in buying into China in general and Baidu in particular.
Baidu would be boring at best -- and disastrous below that.
Enjoy the ride
Thankfully, there are so many favorable variables that Winkler sidesteps in this morning's diss.
If the Chinese economy is half the size of the United States' in four years, Baidu will likely be worth more -- a lot more -- than $40 billion.
For starters, let's consider that Baidu's 73% share in China is greater than Google's chunk of nearly two-thirds of the stateside market. This will fluctuate, of course, but both Baidu and Google have been the undisputed champs in their home turf for years. One can argue that the chances of Baidu's market being gnawed at by Alibaba or Sohu.com's (Nasdaq: SOHU) Sogou are less than Google giving up ground domestically. In China, Baidu's closest competitor -- Google -- is losing share. In the United States, Bing is going to gain ground as a result of its partnership with Yahoo!.
Why are we only dealing with the top line of a country's economy? Let's go down to the bottom line. In its latest quarter, Google clocked in with net margins of 29.7%. Baidu, on the other hand, delivered net margins of 46.4%. In layman terms, Google generated nearly $0.30 in profit out of every dollar in revenue. Baidu -- as the result of lean operations and toiling away in a country with a friendlier corporate tax rate -- milked more than $0.46 in earnings out of every buck received. This point alone should boost Baidu's enterprise value target from $40 billion to $60 billion.
It doesn't end there, though. What do we do with the free cash flow that Baidu will generate over the next four years? How do we account for the inevitable rising of the yuan relative to the greenback? How do we factor in Baidu's growth outside of China? It already launched in Japan, and many schools and universities around the world are teaching their students Mandarin in order to reach out to China's 1.3 billion people.
All of these questions point to even greater valuations for Baidu, but we still haven't touched on the doozy in Winkler's argument.
Right now, Google is trading for 22 times this year's earnings and 19 times next year's target. Does anyone really believe that Baidu will be trading at a year ahead multiple in the teens, when there will still be so much growth to be had? Oh, and shouldn't we be relocating this entire argument to Google's enterprise value and valuation circa 2014?
Keep in mind that China's population is four times greater. If its economy is only half the size of the United States' in four years, it means that it still has an eightfold spurt to go before catching up. Pitting a maturing Google against a Baidu that will still be early in its growth cycle is quite unfair.
Unbuckle those seat belts
Baidu will always be volatile. It will never be cheap.
Bargain hunters may even have problems with new media darling SINA (Nasdaq: SINA) trading at 31 times next year's earnings and leading travel portal Ctrip.com's (Nasdaq: CTRP) heading multiple of 38 -- and those companies aren't growing as quickly as Baidu.
The risks in China are real, even if the country's global credibility would have a lot more to lose than Baidu shareholders if it should ever clamp down on paid search's potential.
You can always spot the folks who think Baidu is overvalued and headed for a fall. They're usually the same ones who were bashing the stock at half of today's price earlier this year -- or even at its IPO before its 40-fold advance.
Do you think Baidu is a good buy at this point? Share your thoughts in the comment box below.
