Baidu (NASDAQ: BIDU) has been built by co-founder and CEO Robin Li into one of the largest and most ubiquitous companies in China in just more than 15 years. He has been so successful because he has focused the company on its core business of online search almost exclusively in its domestic market.
Baidu has been willing to adapt to changing conditions, such as the proliferation of mobile, but it must be careful not to venture too far out of its circle of competence. Its most recent investment -- into the online-to-offline business which connects people online with real-life goods and services -- pushes up against this boundary, but ultimately serves to strengthen and expand the core business.
A popular example of online-to-offline that many readers may have used already involves searching for a product online or on a mobile device, reserving or even paying for the product ahead of time, and then picking up the product in a physical store. It in many ways combines the spontaneity of online shopping with the instant gratification of walking into a store and knowing that you will walk out with the product that you want.
Another common example is deal of the day sites like Groupon. A consumer can purchase a steak dinner for two on their phone but obviously must go to the steak house to redeem and consume their meal.
Search is a cash cow that needs to be prioritized
Online marketing revenues for Baidu were responsible for more than 98% of its total revenue in the latest quarter. This is the engine that has propelled Baidu to a nearly $70 billion market cap. Neglecting it to focus on other businesses that may be more exciting, but don't support this core foundation, would be foolhardy.
Peter Lynch, one of the greatest investors of the last 50 years, has written about the dangers of "diworsification," which is when diversifying into new lines of business that are inevitably not as good as the core business cause a drag on the overall returns of the company. Fortunately for Baidu, this doesn't appear to be the case.
Robin Li's blueprints have shown tangible results
In the Q1 conference call that took place on April 29, 2015, Li said, "We see huge potential ahead for mobile marketing, online to offline, and key select verticals, such as healthcare, education, and financial services, by leveraging our solid mobile foundation, exceptional technology advantage, and proven operational experience." Capitalizing on the proliferation of mobile, which contributes more than 50% of Baidu's total revenue, allows for it to pursue some logical extensions to the business.
Baidu is also making advances into online food delivery, restaurant reservations, banking, Groupon-like daily deals, and many other areas of daily Chinese life. All of these areas are ripe for disruption. In the conference call, Li said:
The majority of consumption and transactions takes place locally and offline. With the rise of mobile, connecting local services from online to offline becomes possible. Bringing services online opens up information transparency and allows for better managing of supply with real-time demand. ... For example, with [the] restaurant industry, a multi-trillion RMB industry in China, behind only real estate and automotive in market size, more than half of seats are left empty daily. Only 1% of reservations are made online. And online take-out food delivery represents only a low single-digit percentage of overall restaurant GMV [gross merchandise volume]. ... By connecting people with services, Baidu is providing users with convenience and choice and enabling merchants to fulfill real-time demand, which can drive incremental revenue and improve capacity utilization. This is the long-term strategy and ecosystem build-out for Baidu.
While all of these areas could be disrupted through desktop computing, the use of mobile makes it easier, and affords opportunities that otherwise wouldn't be available. A young Chinese couple might have their movie tickets on their iPhone, but I can't imagine them lugging a laptop along on their date. In fact, Baidu reported in the conference call that "in Q1, 25% of Nuomi movie tickets transactions originated from and were completed on Mobile Baidu and Maps."
A foreshadowing of the big play to come
Baidu announced on June 11, that it had invested $58 million into a Hong Kong theater operator and production studio called SMI Holdings Group. While this is a relatively paltry sum for a company with nearly $8 billion in annual revenues, it was important for what it indicated about its future direction. An unnamed market analyst was quoted in Want China Times saying, "Baidu's investment in SMI ... is likely to give the Internet giant more power over ticket prices as well as movie selections, publishing and copyright issues in the future."
The pace of the company's move further into the online-to-offline space was rapidly accelerated when it announced on June 30 that it would be investing $3.22 billion during the next three years into online-to-offline services. This investment is about 40% of the cash on the company's balance sheet, and is a major vote of confidence in the O2O space by Baidu's management.
Baidu's success in the mobile space gives it an advantage vis a vis O2O services. As Paul Carsten wrote in a recent Reuters article, O2O services "have traced the growth of smartphone use. Such services let users connect with nearby, everyday activities such as calling taxis, finding deals at local restaurants and booking cinema tickets through their smartphones."
This investment into O2O services supports Baidu's core business
Baidu's goal is to get as many eyeballs as possible onto screens with Baidu software and websites, and then to figure out as much information as possible about the people behind those eyes. Being a part of the process by which people make dinner reservations, buy movie tickets, and hail cabs benefits the company in a few ways.
It opens up the possibility of future revenue streams, as Baidu receives a cut of each transaction. A mobile user may get a coupon on his or her smartphone when close to a store that's frequently searched for on Baidu's search engine. There's a lot of potential for revenue growth in this area. More importantly, it allows Baidu to build more robust profiles of its users to sell to advertisers.
All of this online-to-offline investment ultimately serves the core revenue driver of online marketing, and is good for the company and the long-term investor. For tech investors looking to diversify their portfolios, Baidu may warrant a further look.
James Sullivan owns shares of Baidu and Apple. The Motley Fool recommends Baidu. The Motley Fool owns shares of Baidu. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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.