Baidu Blasts Off

By Greg Sushinsky | October 21, 2010 AAA

Trees don't grow to the sky according to market wisdom and stocks don't live in the stratosphere for very long, but China's internet giant Baidu (Nasdaq:BIDU) may prove this wisdom wrong, at least for now. Baidu turned in a sensational third-quarter earnings report with income that more than doubled on revenue which also skyrocketed.

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Search and More
Baidu now claims 72% of the Chinese search market, the world's largest with 420 million people. Baidu posted a near 80% increase in revenue with $337.2 million compared to $187.3 million in the year-ago quarter. Net income more than doubled to $156.4 million or 45 cents a share from $72.2 million or $2.07 per share, which was prior to the 10-for-one stock split. Baidu increased its market share gains in China after Google's (Nasdaq:GOOG) issues with the Chinese government. Baidu also continues aggressively to pursue other revenue streams, including online video and ecommerce.

China's Still Expanding Market
Not only did Baidu gain market share in search at the expense of Google, but the search market itself in China grew 59% in the third quarter, to $471 million, so Baidu posted gains from market size expansion as well. While Baidu dominates China's search business, it also doubled the number of online retailers advertising with it during the quarter.

In addition to its upgraded Phoenix Nest click ads generating more revenue, Baidu still has the opportunity to grow with contextual ads, which are something like Google AdSense ads. Online video, mobile search and Baidu's version of mobile apps, aren't revenue producers yet, but are expected to eventually be. The company continues aggressive R&D spending with a look to long-term growth.

What Competition?
Google now with only 24% of the search market in China appears to have been tamed. China internet company Alibaba, which is 39% owned by Yahoo! (Nasdaq:YHOO), has thoughts of challenging beyond its ecommerce area in China, as its Taobao unit started search engine Etao recently. Baidu's response? It partnered with Japan's Rakuten to compete in ecommerce against Alibaba.

Rumors also are in the air that Baidu will take over its prime internet competitor, China's leading internet portal, Sohu.com (Nasdaq:SOHU). Sohu's search engine Sogou (which means "search dog" in Chinese) was spun off earlier this year. Another of the Chinese internet players, Sina Corp. (Nasdaq:SINA) is second in China as a web portal with 250 million users, and leads in blog applications. These companies or their spinoffs also feature highly popular online gaming. Sohu spinoff Changyou (Nasdaq:CYOU) is a leading player in the gaming space. None can do what Baidu can at the moment. Baidu has the potential through its ongoing acquisitions or expansions to continue to diversify its business and revenue stream while retaining its dominant position in search.

Baidu Outlook
Baidu's outlook for its fourth quarter sees the company pulling in revenue between $354.2 million and $364.7 million. The stock, which has doubled since January, now trades at over $100 a share and a forward P/E of just under 50. The business space it occupies in China still has a significant demographic for expansion. Baidu is a tremendous company with great long-term prospects and a great stock.

Great Company, Great Stock, But Watch the Expectations
That said, you might want to remember this about trees to the sky: that doesn't go on forever. Each quarter the company's lofty stock price will be harder to sustain, with even a minuscule slip up in growth an opening for the market to pounce and punish. Though we'd love to see a price pullback and a buying opportunity, we don't think that will happen for awhile. Momentum trumps fundamentals for now. (For more, see Investors Beware: There Are 5 Types Of Earnings Per Share.)

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