Dueling Fools: Baidu.com Bull

The bullish camp is feeling lonely this week. That's because Baidu.com (NASDAQ:BIDU) is running a little light on believers right now. The company went public this summer at $27 a stub. It skyrocketed into the triple digits on its first day of trading and now rests roughly three times higher than its $27 offering price. That has prompted many investors to bash the stock, as I'm sure Charly Travers will today, on valuation terms. The line of Baidu haters forms to the left, please. Even the company's own underwriters have been lashing out at the fledgling upstart. Goldman Sachs initiated coverage on Baidu earlier this month with an "underperform" rating, citing fair value for the leading Chinese search engine of $27.

With friends like that, who needs enemies?

Baidu, or "Buy, dude!" as David Gardner recently mused, has also been targeted by the major record labels because the site is a hotbed for Chinese youth trying to track down free downloads of the latest hit records.

Baidu bears have it wrong, though. The stock is not overvalued once you dig beneath the surface. Baidu's trailing revenue wouldn't seem to justify the company's $2.5 billion price tag at the moment. However, Baidu is also extremely profitable. Thanks to its shrewd operating prowess and China's low tax rates, Baidu sported 17.6% in net margins this past quarter.

That's significant, because for all the talk of Baidu being a Baby Google or Yahoo! (NASDAQ:YHOO) in training, neither of those stateside search darlings were nearly as efficient as Baidu has been in turning a profit this early on. Here's how Google and Yahoo! were doing when their revenues were in line with Baidu's today:

Baidu is profitable, with rich double-digit net margins right now. Yahoo! didn't shake the red-ink stink until its top line hit $591.8 million in 1999. Google made it earlier in its tenure, but last year the company produced $399.1 million in profits on $3.2 billion in revenue. That's a respectable 12.5% showing in net margins, but it's a far cry from what Baidu has working in its favor right now.

That's the substance. Here comes the story. The reason that Baidu is still so early in its revenue growth cycle despite being the market leader in the world's most populous nation is that most of China is not online. In fact, just 10% of the country's 1.3 billion residents have Internet access. How would you have liked to buy into Microsoft (NASDAQ:MSFT) when just 10% of the country knew how to boot up a PC or Starbucks (NASDAQ:SBUX) back when just 10% of the country was sipping premium java blends? That's the opportunity you have here with Baidu.

Baidu operates in a region where the average person makes $1,300 a year, so it will take time. However, that too, is just more eventual upside for Baidu as China's heady economic growth filters down to its citizenry. Right now you can scoop up shares of Baidu for less than $2 for every Chinese resident. Yahoo! is trading at $153 for every U.S. citizen; eBay (NASDAQ:EBAY) is at $176. Google? A whopping $297 for every stateside head.

You can argue that it's an unfair comparison. You could make the case that these companies are already prolific producers overseas. You're right. So let me ask you this. As China becomes a more economically potent nation, and more business-savvy outsiders start brushing up on their Mandarin, where do you think they will seek out new opportunities? You can do a lot worse than Baidu.

As for the battle against Baidu for providing links to sites that offer illegal downloads, a fifth of Baidu's searches are music-related. That's not nearly enough to make it dependant on piracy for fuel. Besides, does anyone remember how the battle against the file traders wound up here? Some of the networks were transformed into legal subscription sites, like Napster (NASDAQ:NAPS). However, the labels also realized that they had to embrace the enemy. Apple Computer (NASDAQ:AAPL) upset the industry with its "Rip, Mix, Burn" marketing mantra. But the record labels came knocking on Apple's door when its access to the wired youth made it the leading distributor for paid music. I'm not saying that this will play itself out exactly the same way, but you have to think that history will shine kindly on Baidu given its primo position in the one country where there is so much potential beneath the surface.

Wait! You're not done. This is just a quarter of the Duel! Don't miss the Bear opening argument and the Bull and Bear rebuttals. Even when you're done, you're still not done. You can vote and let us know who you think won this Duel.

Fool contributor Rick Munarriz believes in investing in China and even recommended another fast-growing Chinese company that has soared by 78% since it was singled out in Motley Fool Rule Breakers nine months ago. You can find out more with arisk-free trial subscription. Rick does not own shares in any of the companies mentioned in this Duel. eBay is aMotley Fool Stock Advisorpick. The Fool has a disclosure policy.