Jefferies initiates BIDU with buy, Top Pick, PT $200
Baidu Inc. (BIDU) Search: In a World of Its Own EQUITY RESEARCH ASIA BUY Price target $200.00 Price $145.68
Cynthia Meng * Equity Analyst 852 3743 8033 email@example.com Joshua Wu * Equity Associate 852 3743 8035 firstname.lastname@example.org Anita Chen * Equity Associate +852 3743 8034 email@example.com * Jefferies Hong Kong Limited Key Takeaway We initiate coverage of BIDU as our top pick in the space with a Buy rating and PT of USD200, 38% upside to current price. As the number one search marketing player, Baidu enjoys a very high entry barrier, limited competition, a growing market with still low SME online marketing penetration, and an early opportunity in mobile search. Un-monetized traffic still accounts for over 55%, and online video JV Qiyi offers huge potential. Growth will be sustained given still-low Internet and e-commerce penetration. We expect search advertising revenue share of total online advertising in China will continue to increase driven by the nascent opportunity from mobile search, and SME search marketing as more Chinese SMEs conduct business online, and the Chinese economy depends more on domestic consumption than on export. We estimate revenues to grow at 73% and 65%, and earnings to grow 76% and 64% for 2011-12E, respectively. Search market has a very high entry barrier and limited competition. As the number one search engine with very high brand recognition in China, BIDU has thousands of service personnel and R&D engineers dedicated to Internet search in China, making it very difficult for competitors to achieve critical mass or match its quality of user experience. Industry checks indicate that Google’s exit from China in 2009 has and continues to benefit BIDU in China’s search market. Competitive positioning and scale economy increases bargaining power. Traffic acquisition cost (TAC) to sales ratio has been trending down since 1Q10, coinciding with Google’s exit from China. As market share expands by both traffic and revenue, Baidu has successfully lowered its average payout ratio to 3rd party websites. Despite investments, we expect BIDU to have a stable margin given limited competition and scale. Valuation/Risks Our PT of USD200 is based on 0.8 PEG for 2011, implying 69.9x and 41.5x forward PE based on our estimates for 2011-12, respectively. This is an 11% discount to the 2011E China nongame Internet peer group avg PEG of 0.9. At the current price, the stock is trading at a 0.6x PEG ratio, implying a 33% disc. to peer average PEG. On a PE basis, BIDU is trading at 50.9x forward FY11 P/E, 43% premium to peer group of 35.6x. Risks include economic slowdown and slower than expected SME e-commerce and Internet penetration.