Baidu Valuation Cut in Half as Ad Sales Slide Dims Profit

Story originally appeared on Bloomberg.

Baidu Inc. (BIDU) is trading more than 50 percent below its average valuation over the past five years as the Chinese Internet company struggles to diversify while maintaining profit growth amid a slowdown in advertising.

American depositary receipts of Baidu, owner of China’s most-used search engine, sank 7.9 percent April 26 to trade at 15 times estimated earnings. That compares with an average multiple of 36 since 2008, data compiled by Bloomberg show. The slump drove a 1.4 percent drop in the Bloomberg China-US Equity Index of the most-traded Chinese stocks in the U.S.

Baidu tumbled the most since February in New York after reporting net income rose 8.5 percent in the first three months of 2013. Profit growth has slowed from an average 64 percent in the previous five quarters as revenue from advertising dwindled. The Beijing-based company, which most recently acquired online video firm iQiyi.com, wants to buy up mobile applications as consumers shift to smartphones from personal computers, Chief Executive Officer Robin Li said April 25.

“Baidu is spending a lot of money to maintain its market position and search for new growth engines,” Echo He, an analyst at Maxim Group LLC in New York who rates the stock sell, said in a phone interview April 26. “The investment doesn’t necessarily translate into revenue growth. The profit margin will continue to be under pressure.”

Baidu’s first-quarter gross margin, a measure of profitability, was 65 percent, down from 71 percent a year earlier. The company’s net income of 2.04 billion yuan ($331 million) in the first three months was 6.8 percent below the median of eight analysts’ estimates compiled by Bloomberg. Revenue per online advertising customer fell 6.5 percent from the fourth quarter, according to the earnings statement.

Competition Intensifying

The ADRs, which slid to an almost three-week-low of $85.02 April 26, have retreated 36 percent over the past 12 months as Baidu grapples with rising competition from companies such as Qihoo 360 Technology Co. (QIHU), a software developer that debuted a search engine in August. Qihoo, also based in Beijing, said last month that its operating margin will “see the bottom” in the first quarter due to costs associated with expanding into mobile Internet.

Baidu -- which accounted for 82.3 percent of Chinese search-engine queries in the fourth quarter, according to Bloomberg Industries -- wants to extend its dominance of China’s search market to mobile devices and favors acquisitions over building the company, CEO Li said on an April 26 conference call. The iQiyi.com purchase was still “burning money,” he said.

“Nobody can prove they can make money from online videos, and to keep up with the growth rate of the past they need to invest in new businesses which are just not as profitable as the search business,” Jeff Papp, a senior analyst at Oberweis Asset Management Inc., which manages $700 million in assets including Chinese equities, said by phone from Lisle, Illinois April 26. “The company is undergoing a transformation and it’s hard to get visibility.”