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MattC: Baiduers Will Win Big, If They Stomach The Short Term
When it comes to Baidu, I hear a lot that "the products sucks, it always has. It was a matter of time before they were exposed." My answer to that is: Ridiculous. I have been in the Internet industry for 12 years. I have never seen a product gain 65% market share by having a crappy product. The Internet really is the ultimate meritocracy. The best product wins and usually wins big. Unless you see user behavior and market share plummet, be careful about writing Baidu off. To me this is all about market share. The revenue could have a hiccup in the short term but it will get figured out within a few quarters and be back on track as long as they maintain dominant user share.
Internet habits die hard. Further to the above argument, it takes A LOT to change user behavior. Case in point…"How good is Microsoft's search engine in the U.S.?" I am sure it is quite good. But I would not know because I am perfectly satisfied with Google in the U.S. and never use Microsoft’s search product (or Ask.com etc. etc.). The counter is of course to say "Yeah, but what about Yahoo! in the U.S.? They owned the market. Then along came Google and WHAM!" That's true, but you will see that show up in the market share well in advance of an implosion.
The China search market is a 2 horse race. The winner will be either Baidu or Google. The fact is that it will never be Google. Just ask any foreign company operating in China. The Chinese government will never allow it. Pride and security reasons mean that if Baidu can keep the train on the tracks right now they win and win big. Don’t underestimate the security issue. This is a government that runs a close second to North Korea in paranoia.
Baidu now trades at less than a $4 billion market cap. It's not far off from its IPO price back in 2005. 2008 revenue will be close to $500 million. Last quarter, revenue grew at 85% year over year. Also, iResearch recently forecast that the paid search market in China will be about $2 billion in 2011. If Baidu stays on track, they will capture $1.2 billion of that revenue at a minimum. That does NOT include display ads and other online advertising revenue. Even Yahoo!, with all its woes right now, trades at a $15 billion market cap. The numbers on Baidu are getting really interesting at these prices.
Trading risk. Clearly there is short term trading risk. I have talked with a number of fund managers who were alarmed at the recent CCTV/Baidu debacle. ("I can't live with the fact that I could wake up one morning and find Baidu trading at $75/share.") That has decidedly put them on the sidelines until Baidu sorts itself out. My guess is that most will wait 1-2 quarters. Also, this is the age of negativity. Bears obviously rule this market right now. The day the new lawsuits were announced Baidu lost 14%. However, my sense was that Baidu would have lost 14% anyway when the Dow traded down nearly 700 points. Google almost lost 10% that same day.
Baidu is not Focus Media (Nasdaq: FMCN). Outside of this recent hiccup, Baidu's management has arguably managed pretty well. There was some executive turnover, but they haven’t had any major blow ups until now.
The lawsuits. If Baidu is skilled at anything, it is skilled at fighting lawsuits. Just ask the music industry. They are very likely to survive ambulance chasers in China. The Chinese government is unlikely to support many of these suits. If they wanted to sink Baidu, they would be running follow-up exposes 24/7 on CCTV which they have not done. In fact, they recently ran a piece saying more or less that "Baidu has learned its lesson and will be better and stronger as a result of this mistake."
Bottomline: If you can stomach the short term swings, you could win big on Baidu if the train stays on the tracks. Focus on market share as opposed to short term revenue hiccups. The opportunity is that most fund managers are on the sidelines for 1-2 quarters. Most readily admit that "Baidu will still be around. It’s not going anywhere." Yet, at these prices, it is quickly being priced as if it is going out of business.
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Matt Comyns is the chief executive of JLM Pacific Epoch.
