Baidu's Challenge: Expand Beyond Its Success in China

Lianting Tu|Special to has been an Internet success story since it went public in 2005. But while the Chinese Web search engine dominates the rapidly growing Chinese market, it has only a minor presence outside of its home country.

That hasn't stopped Baidu from dreaming big. It wants to move beyond China and take on Google, and Yahoo in Internet search throughout Asia.

Chinese Internet Cafe

Baidu today wants to be the Google of Asia, especially with respect to ads placement," says Paul Kedrosky, Consulting Strategist at Ten Asset Management.

Yet many still consider Baidu a single-country play, whose fortunes rise and fall with the Chinese economy.

“Baidu today is leveraged to a single economy for the majority of its revenue, so could face more concentrated regulatory and market risks than globally diversified competitors,” says Jordan Monahan of Global Investment Research at Goldman Sachs.

Baidu, which began as an Internet start-up about ten years ago by a U.S.-educated Chinese computer engineer, now commands 60% of the paid search market share in China, according to data from Analysys. By contrast, Google is a distant distant second in China, holding about 30%.

Baidu's dominance of China is expected to continue as more Chinese go on the Internet.

“In China if you search in Chinese, Baidu is the place to go,” says Paul Keung, who covers Baidu at Oppenheimer Equity Research.

Mainly for that reason, Baidu's stock has soared from its initial IPO price of $27 a share to nearly $400 now. And while many Internet companies got hammered during the global economic meltdown during the past year, Baidu is up a whopping 91%.

Analysts from Goldman Sachs are looking at Baidu’s revenue growth rate at around 30% to 40% from 2010 to 2013, verses 10%-12% for Google.

“Only 26% of China’s population is online,” says James Mitchell, Equity Research Managing Director at Goldman Sachs, “Baidu remains our favorite stock for its potential in search traffic growth.”

Even Google CEO Eric Schmidt acknowledges the tremendous growth potential in China. Schmidt said at a recent industry event that he expects the Web to have significantly more content in Chinese by 2014.

“The right question is whether Baidu can build a Chinese language beachhead that Google can't adequately assail,” Kedrosky says.

For now, Baidu is known as "China's Google Killer." And the potential growth is still huge. According to IT consulting firm ComScore, home and work Internet user population in China has grown three-fold the past year alone.

As of now, only 1% of China’s businesses have been advertising through Baidu. A latest Goldman report carried it even further: “We do not see where else (Chinese) search advertisers could spend their budgets other than Baidu, given Baidu’s industry dominance.”

Baidu’s success owes largely to its ability to leverage local knowledge and therefore delivers more desirable search results.

“Compared with Google, Baidu is more in tune with the Chinese culture,” says Baidu’s spokesperson Victor Tseng.

He uses an example of a search query “she” (a famous girl band in Taiwan). Instead of results irrelevant to the Chinese as Google and many other search engines would churn out, Baidu’s top results are the S.H.E. Taiwanese girl band in Chinese together with their downloadable music. Therefore when it comes to searching in Chinese, the Chinese search with Baidu.

Receptionist at office

Google initially invested in Baidu hoping to gain entry into the Chinese search market. But it sold its minority stake in 2006 and is now competing directly with Baidu.

That battle is also heating up in the mobile search territory in China, which is home to about 600 million to 700 million mobile users, about double the size of its Internet users. There are about 40 million mobile Internet surfers at the start of the year. And the number is expected to grow very rapidly.

But even with the explosive growth in China, Baidu has even bigger ambitions. It already has moved into the Japanese search market and wants to become an international household name in about fifteen years. Currently Baidu does not offer an English-language search function. They index predominately Chinese related content.

Analysts, meanwhile, are concerned that Baidu’s transition to its new online marketing system Phoenix Nest will lead to softer revenue growth into the next year. In a longer term, Baidu's growth may be more volatile given the firm’s exposure to the regulatory risks from the Chinese government, compared with Google.

Goldman has cut Baidu’s six-month target price to $435 from $455 to reflect a weaker 4Q revenue base.

Still, many find Baidu stock an attractive investment based on the revenue projection backstopped by China’s unrivalled Internet user base and prospering economy. Baidu’s new online key word bidding system, according to both Goldman Sachs and JP Morgan reports, will lay the foundation for a more dependable search engine in the future and opens up for more growth. The question is when.

“Baidu can take on Google globally, in theory, but I don't think it currently has the execution skills – people— to credibly pull that off,” Kedrosky says.