Baidu Needs To Focus on Display Ads To Diversify Revenues

Baidu (NASDAQ:BIDU) is China’s largest search engine by a large margin, controlling more than 80% of the search market. However, competition from new entrants such as Qihu is threatening Baidu’s dominance, and caused the stock to drop more than 35% since August (it has since recovered and is down 25%). Due to this drop in price, we think that Baidu’s management must shift its over-reliance on search (which makes up around 60% of the company’s value), and diversify its revenue streams by investing some of the “war-chest” it raised in its display ads business. To improve display ad revenues, we think that the primary two services that Baidu must focus on are, its music service Baidu Music and its Hulu like service, iQiyi.

See our compelte analysis of Baidu here

Baidu Can Leverage Search Dominance to Drive Display Growth

Since Baidu is the primary search engine in China, with around 80% market share, it has first access to a Chinese consumer searching for access to a service. The company already leverages this by promoting its site Baidu Music on its results page, without needing to discriminate against other companies in terms of the actual search results. At present, it allows users to download a song they search for on to their local machines and redirects users to its site if they want to listen to the song immediately.

In addition to this, we think that Baidu can also make all songs on Baidu Music directly playable on the search results page and can show or play an ad for the user before the song plays. This way it achieves getting paid for the ad, pushing a user on to Baidu Music, and not forcing a user to load a new page. This strategy can also be used to drive revenues on Baidu’s video service iQiyi, by allowing users to play a video on the search page and showing a video ad against it.

If the company is able to leverage its search dominance to increase the number of users to approximately 750 million by 2019, we would see the display division’s value increase to 35% of Baidu’s stock. We think that this is possible because the number of Chinese Internet users is growing at a rapid pace, but is still at only around 40% of the population at 538 million. ^[1] This combined with the fact that Internet ad spending is expected to grow 55% in 2012 and 35% in 2013, will help Baidu diversify its revenue base. ^[2]

Opportunity in Video

According to research firm Analysys International, Chinese online video ad spending tripled to $325 million in Q1 2012, when compared to the same period in 2011. ^[3] We expect that this growth will remain strong over the next 3-5 years, presenting a lucrative opportunity to online video players.

We think that Baidu is in prime position to capture much of this growth due to its Hulu like service, iQiyi. The site, since its inception in 2010, has consistently gained market share, and has become a leader in the Chinese online video market. iQiyi leads the Chinese online video industry in terms of time spent per user per day, and is second in total time a user spends on it per month. ^[4] Overall, both of these factors should help Baidu capture a substantial chunk of the Chinese online video ad spending market over medium to long term.

Another plus point for iQiyi is its high traffic on mobile devices, approximately 20% of iQiyi’s traffic was generated from mobile phones in Q3 2012. As Chinese 3G penetration and mobile web views increase over the coming years, we expect the total views from mobile to increase. This combined with the 7x increase in mobile advertising spending forecasted by eMarketer, gives Baidu an opportunity to use iQiyi, to also drive revenues on the mobile front. ^[5]

We currently have a $125 price estimate for Baidu, which is approximately 25% above the current market price.

Click Here To Understand What Drives A Stock At Trefis

1. Statistical Report on Internet Development in China, CNNIC [↩]
2. China ad spend ‘to increase by 13.4% in 2012’, NetImperative [↩]
3. Online Video Ad Revenues more than tripled in China, MediaBuzz [↩]
4. Baidu Earnings Call Transcript, Seeking Alpha [↩]
5. US on Track to Become Top Mobile Ad Market, eMarketer [↩]