I'm a fan of three things: Baidu.com (Nasdaq: BIDU), Google (Nasdaq: GOOG), and zany analyst ratings. I'm also fond of Lemonheads candy, Arrested Development reruns, and wearing Motley Fool jester caps, but that's another story.
My point is that I landed the trifecta yesterday when Canaccord Adams analyst Colin Gillis initiated coverage on both Baidu and Google. He pegged Baidu as a sell, with a $265 price target. Google was rated a buy at $755.
As a fan of both companies, I have mixed feelings on the divergent calls. I guess what really got my goat was that Gillis thumbtacked Google to his "Best Ideas" list, suggesting that the company will benefit from the advertiser migration to the Web, as well as its luster as a recession-resistant play given its international exposure.
He's right on both counts. It's just that if I owned a record shop and someone came in raving about Google given those characteristics, I'd grin wildly as I blew dust off a vinyl import: "If you like Google's beat, you're going to love this Chinese artist called Baidu.com."
After all, international revenue accounted for about 48% of the revenue mix at Google through the first three quarters of 2007. At Baidu, well, it's pretty much 100% international. If you think it's impressive seeing domestic advertisers in a country of 300 million moving to Web-based sponsorships, you just have to love Baidu serving a country of 1.3 billion residents where the adoption curve is even earlier in its migratory infancy.
I don't even have to own a record shop. I can head over to Baidu's page on Motley Fool CAPS to see a stock-recommendation engine in full swing. The best bearish fit for investors who feel that Baidu will underperform against the market is Google. The best bullish fit for investors who feel that Baidu will outperform the market is Apple (Nasdaq: AAPL)-- but Google takes the silver.
The myth of costly expansion
I understand that Google and Baidu aren't connected at the hip. Gillis has his valuation concerns when it comes to Baidu, especially given the company's costly growth initiatives as it expands into Japan and takes on Taobao with a consumer auction site in China. Google is entertaining the notion of spending billions in the wireless spectrum license auction, and Gillis is afraid that Baidu may be spending too much on ventures that may not pay off the initial outlay right away.
I'll tell you, I'm not worried about Baidu bankrolling expansion. The company spent money on these initiatives last year, and it still blew past analyst estimates. Just take a look at Baidu's third-quarter results. The company earned $0.72 a share before stock-based compensation expenses. That includes an $0.08-a-share loss in Japan. Did the market spit the stock out? No, because the weak-armed analysts were looking for Baidu to earn just $0.63 a share during the period.
Baidu has been pouring its money into new Web candy since its inception. Take a look at the dozens of Chinese applications that Baidu has going on beyond its flagship search stronghold. Do you think they materialized overnight? Of course not. Along the way, Baidu has trounced Wall Street's profit targets in five of the past six quarters (and the lone exception was when it simply met expectations three quarters ago).
Frustration station over valuation
I realize that Baidu isn't the cheapest stock on the planet. With stocks like NetEase (Nasdaq: NTES), Giant Interactive (NYSE: GA), and The9 (Nasdaq: NCTY) trading at forward earnings multiples in the low teens, Baidu isn't going to attract value vultures within China itself.
However, Baidu's growth rate has been on a tear. We're still two weeks away from the company's fourth-quarter report, but the pros expect earnings to grow 118% larger for all of 2007. The consensus estimate calls for profits to climb 77% this year. If Baidu trades at Gillis' $265 target a year from now, it would carry a multiple of 64 times trailing earnings.
That may seem high, but keep in mind three things:
- Earnings are growing at a healthier clip than that.
- Analysts have had a tendency to underestimate the company's profit power.
- The likelihood of a strengthening yuan relative to the battered buck may further inflate the Chinese company's earnings for stateside investors.
I have no beef with being bullish on Google, but Gillis' target of $755 implies an earnings multiple of 36 on a company that is projected to grow its bottom line by just 34% this year. Yes, Google is worth it, but why the cold feet on a much-faster-growing Baidu?
If the argument goes that there are risks in China, and that companies like Google and Sohu.com's (Nasdaq: SOHU) Sogou pose market-share threats, shouldn't the expansion into the richest country with a character-driven alphabet -- Japan -- be applauded?
I'm scratching my head, but I guess that's why I'd rather consume an outlandish analyst call than a box of Lemonheads.
And you know how much I like those Lemonheads.
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