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Stop Raining on Baidu's Asset-Selling Parade

By Rick Munarriz – Jul 19, 2016 at 12:28PM

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Acacia Parnters objects to the insider fueled $2.8 billion deal for iQiyi, but there's more to Baidu's video unit than meets the eye.

Image source: Baidu.

There's a new wrinkle in Baidu's (BIDU 0.44%) plan to unload its majority stake in its profitless but growing video unit. Hedge fund operator Acacia Partners put out an open letter to CEO Robin Li yesterday, urging the leading Chinese search engine to reconsider the transaction that it sees as a conflict of interest.

Baidu's board announced in February that it had received an offer -- led by Li and iQiyi CEO Yu Gong -- to take the streaming video portal private. The deal valued all of iQiyi at $2.8 billion, valuing Baidu's 80.5% stake at roughly $2.25 billion.

The market loved the news, sending shares of Baidu sharply higher. As fast as iQiyi is growing, monetizing chunky video streams has been a challenge in China. It was losing money, so investors seemed excited about the deal improving Baidu's bottom lines while padding its already ample coffers. Baidu's market cap increased by $4 billion the day the offer was made public, but it's not enough for some apparently.

Deal or no deal

There is some logic to Acacia's bones of contention. Youku Tudou -- iQiyi's biggest rival, and a hub that Baidu often claimed it was ahead of regarding certain popularity metrics -- was acquired in a deal valuing it at $4.8 billion back in April. Like iQiyi, Youku Tudou was growing quickly but bleeding quarterly deficits. Is iQiyi really only worth 58% as much as Youku Tudou?   

Well, it's now been more than five months since a pair of Baidu insiders proposed to take iQiyi off of its parent company's hands. If an outsider had a better offer don't you think it would have happened? Pride can be a dangerous thing when the front porch of potential suitors is empty. 

There's also the fear of missing out. Google parent Alphabet (GOOG 1.56%) is the global leader in Baidu's flagship search business, and it's coming under fire for spinning off Niantic Labs late last year. Niantic Labs is the app developer of the Pokemon Go mobile game that has become a national obsession. Alphabet is retaining a minority investment in Niantic Labs, but one can imagine how Alphabet shares would be buzzing if the company behind the Android mobile operating system was also the sole owner of the mobile app that's taking the world by storm.

Acacia argues that Baidu can spin off iQiyi as its own IPO, though the market's cool stance to Chinese IPOs -- and profitless dot-coms in particular -- may prove sobering. Youku Tudou was languishing until one of the few companies that could afford to spend billions on a deficit-riddled business stepped up. Acacia also suggests that Baidu should maintain partial ownership as a way to ride iQiyi's success while taking the red ink out of its bottom-line results, but isn't that the same bittersweet situation that we're now seeing with Alphabet and Niantic Labs?

It's true that iQiyi is growing faster than Baidu, and cutting it loose will result in organic top-line growth decelerating. However, the concerns with Baidu in recent years have revolved more about margin contraction than revenue growth. If someone is willing to pay more than $2.8 billion for iQiyi it would obviously be in the best interest of shareholders to go that route, but let's not dismiss the allure of keeping the video unit close with Baidu insiders that will likely continue to lean on the platform to serve its online advertising needs.  

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 (C shares) and Baidu. 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.

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