Technology Investors: One Reason to Be Bearish on Baidu, Inc. (NASDAQ/BIDU)

Technology InvestorsChinese search engine giant Baidu, Inc. (NASDAQ/BIDU) took a huge hit in its stock price on Tuesday July 28th. Why? The company just released its second-quarter earnings. (Source: Baidu Inc., July 27, 2015.)

The top line numbers look great. Total revenue increased 38.3% year-over-year to $2.67 billion in the second quarter of 2015. Moreover, mobile revenue accounted for 50% of total revenue.

Net income was less impressive. For the reporting quarter, Baidu’s net income was $590.6 million, a mere 3.3% increase year-over-year. Adjusted earnings per share (EPS) were $1.81.

Despite the somewhat decent earnings report, Baidu’s stock price plunged 15% on Tuesday to $168.03 a share. The company’s stock price has been declining consistently since its 52-week high of $251.99 reached last November.

The huge drop in share price for the company resulted in a massive cut to its market value. Over $1.0 billion of Baidu’s market value evaporated in just one day!

Baidu’s earnings report also prompted downgrades from analysts. Both Deutsche Bank AG (NYSE/DB) and Brean Capital downgraded the company from “buy” to “hold.”

“With Baidu’s cornerstone search business delivering solid growth and enjoying ample runway ahead, and with powerful mobile gateways to leverage, we are ideally positioned to capture the O2O e-commerce opportunity and build the ‘Next Baidu,’” said Baidu’s Chairman and CEO Robin Li.

“As we continue to connect people with services and enable closed loop transactions, we are creating a transactional business model as Baidu grows and evolves in the age of mobile.”

The main source of Baidu’s revenue was online marketing. The segment generated $2.62 billion of revenue, a 37.1% increase year-over-year. The company also grew its active online marketing customers by 20.9% to approximately 590,000 in the reporting quarter.

Baidu has been trying to expand its business, but it came at a cost: expenses surged. In the second quarter of 2015, selling, general, and administrative expenses (SG&A) increased a whopping 81% to $627.4 million. The increase was mainly due to Baidu’s promotional spending for its online to offline (O2O) business.

The company also increased the number of its research and development (R&D) personnel. This led to a 56.2% increase in R&D expenses to $437.5 million for the quarter.

For the third quarter of 2015, Baidu expects total revenue to be in the range of $2.9 billion to $3.0 billion, representing a 34.4% to 37.3% increase year-over-year.

O2O Business: Too Late in the Game for Baidu

The online to offline business is booming in China. But Baidu might be too late to join the party.

There are some big players in the game., a group buying website, has hundreds of thousands of business connections. The company is backed by Alibaba Group Holding Limited (NYSE/BABA) and Sequoia Capital China.

Meituan was the pioneer in China’s group buying industry, and one of the few that survived over the years as competition got intense. It now has the leading position in the business with 20 million daily mobile users in more than 1,000 cities. Meituan raised $700 million earlier this year, giving the company a $7.0 billion valuation.

Another giant in the O2O business is Dianping Holdings Ltd, a Yelp-type website that also offers group buying services. In its latest round of funding, the company raised $850 million from a group of investors, giving Dianping a valuation of over $4.0 billion.

Baidu’s stake in the O2O business includes its Baidu Nuomi, a group buying site, Baidu Takeout Delivery, and a few others. Its huge presence in the Chinese internet industry gives it some advantage, but it would take a significant amount of investments to compete with O2O giants like Meituan and Dianping.

As a giant company, Baidu is going to enjoy revenue growth as more users in China get connected to the internet. But to carry out its plans in O2O and such, significant investments have to be taken. That is going to affect the company’s bottom line in the short term, and investors do not seem to like that.