Shares of Baidu (NASDAQ:BIDU) soared 8% on Friday, after China's leading search engine received a buyout offer for its growing yet profit-draining iQiyi streaming video portal.
Baidu is no stranger to the potential buyers. Baidu founder, Chairman, and CEO Robin Li is joining iQiyi CEO Yu Gong as the two proposed buyers offering to take iQiyi off Baidu's hands in a deal that values the popular video site at $2.8 billion. Baidu owns 80.5% of iQiyi, so it would receive roughly $2.25 billion if the transaction goes through.
Baidu's board has formed a special committee consisting of three independent directors to evaluate the deal. We know what the market thinks of the offer. Baidu's market cap gained nearly $4 billion in market cap on Friday following the news.
Let that sink in for a spell. Mr. Market is saying that it thinks Baidu is worth $3.98 billion more now that there's an offer to take iQiyi off of its hands for $2.25 billion. In short, it thinks that iQiyi is worth less than worthless.
That's clearly not the case. iQiyi is a worthy rival of Youku Tudou (NYSE:YOKU), and it commands a market cap north of $5 billion. They have different models. Qiyi is trying to differentiate itself by emphasizing unique content and its business handset distribution model. Youku Tudou may reach a larger audience, but it's not like the stateside market, where Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) YouTube is the undisputed platform, and nobody else is even close. There are plenty of significant players in China, and if Youku Tudou is worth more than $5 billion, then it's easy to wonder if iQiyi is worth more than $2.8 billion.
The point may be moot. The market has decided that Baidu is worth more without iQiyi than with it, and the special committee of independent directors won't have much of a choice but to follow the stock gains.
Mr. Market is actually right this time. As much as Baidu would love to rip another page out of Alphabet's playbook and remain a dominant player in video, it will probably be several years before it turns profitable. The platform is a major drag on Baidu's bottom line. It reduced its adjusted margins in 5.4 percentage points in Baidu's latest quarter.
This wouldn't matter if the market were buying into Baidu's long-term investments that aren't paying off anytime soon, but sentiment has turned. Baidu's been the subject of several downgrades in recent months, typically because the dot-com giant's emphasis on profit-slurping online initiatives is weighing on the bottom line. As important as these side projects may seem -- and we know how YouTube turned out to be more than a side project for Google parent Alphabet -- it's deficits are getting in the way of investors bidding the stock higher. That makes this the right call for Baidu at the moment.
To paraphrase The Dark Knight, a diversified Baidu is the hero that China's dot-com economy deserves, but not the one it needs right now.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and 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.