Oh, how the cynics love to pile on Baidu.com (NASDAQ:BIDU). After coming to market as one of the hottest IPOs of 2005 and nearly doubling in 2006, the bears are positioning themselves for a fall in China's red-hot market (in general) and Baidu (in particular).
As a poorly rated one-star stock in the Motley Fool CAPS service, skeptics aren't convinced, despite the heady production that has found Baidu lapping Wall Street's expectations in four of its first five quarters as a public company.
Let's address some of the challenges and opportunities that lie ahead for this recent Motley Fool Rule Breakers newsletter recommendation.
Challenges to overcome
- Despite its spectacular run into the triple digits after its $27 IPO late last year, it won't be a cakewalk for Baidu over the next 12 months.
- Despite a recent win against China's record labels, Baidu is still considered to be a piracy facilitator because of the popularity of MP3 downloads from its site.
- China is a dynamic market, with better than 10% annualized growth over the past few years, yet it still represents a risky developing market and one that is ripe with geopolitical risk, given the country's restrictive government.
- The company has managed to grow its market share over the past year, yet one can't assume that stateside giants like Google (NASDAQ:GOOG) and Yahoo! (NASDAQ:YHOO) will take things lightly.
Reasons to be hopeful in 2007
If the challenges appear pretty daunting, they've got nothing on the potential upside if things pan out.
- Earlier this month, Baidu announced that it would be entering the Japanese market in 2007. They clearly are different markets and Baidu will be the outsider this time, but the more attractive ad market and established Internet audience make Japan too rich to pass up for expansion.
- Baidu has taken advantage of its popularity, especially with younger users that make up most of the site's usage, to roll out sticky sites for everything from blogging to discussion boards. With just 10% of China currently online, there's plenty of opportunity to widen its reach in as many ways as possible.
- The company has truly become the Google of China, with recent deals to populate the pages of sites run by eBay (NASDAQ:EBAY) and Microsoft (NASDAQ:MSFT) with its paid search ads. With its huge list of sponsors, rivals are unlikely to catch up and may soon realize that it is smarter to partner with Baidu than to fight against it.
- Throughout 2006, earnings grew at a faster clip than revenues. It will be a challenge to continue that trend in 2007, but the company is already working on fat margins, even if they're not as fat as those of rivals like online gaming giant NetEase (NASDAQ:NTES).
Baidu's seemingly lofty valuation
Analysts expect profits to soar 89% higher, to $1.76 a share over the next twelve months. The top line is supposed to rise 92% higher to hit $199.8 million. At a recent price of $117, Baidu is fetching 66 times forward earnings and nearly 20 times forward sales.
Expensive? You bet. However, factor in a few things:
- China's growth potential, with 90% of the country still not online.
- A booming economy where disposable income and ad budgets will likely grow faster than in the rest of the world.
- Expansion into richer Asian markets, like Japan.
Sure, there is political risk. That's the kind of sneeze that can send the market crumbling. Yet Rule Breakers are willing to take on that kind of risk. The newsletter service that bears its name specialized in story stocks, and taking chances is what investors do when they swing for the fences. Baidu offers all of the allure of a smoking fastball hurled right over the plate. Strike out? Maybe. Homer? Maybe. You never know until you swing away.
Check out the other companies featured in "The Motley Fool's 2006 in Review and 2007 Preview" special.
Baidu is a recent selection in the Rule Breakers growth stock newsletter service, where NetEase is also a recommendation. Microsoft is an Inside Value pick. eBay and Yahoo! are Motley Fool Stock Advisor recommendations.
Longtime Fool contributor Rick Munarriz has been to mainland China just once, but he's longing to brush up on Mandarin and make it another go in the future. He does not own shares in any of the companies mentioned in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.
