Imagine a company so dominant in a market that Google could only stand on the sidelines. Moreover, that market has more than one billion people. I’m talking about Baidu Inc (ADR) (NASDAQ:BIDU) stock, the #1 search engine in China.
Normally, if a company manages to accomplish something like this, its stock should skyrocket. But that hasn’t been the case lately. While GOOG stock surged 29.3% over the past 12 months, BIDU stock tumbled 34.0%.
Of course, the turmoil in China’s stock market last year added some downward pressure to Baidu stock. But here’s the thing: while China’s economic growth might be slowing down, Baidu’s outlook has never been brighter.
Let me explain…
Baidu has been investing heavily in China’s online-to-offline (O2O) commerce industry. Essentially, O2O brings consumers from online channels to physical stores. For example, a consumer can book a haircut appointment using an app on their smartphone and go to the barber to get the haircut.
Results from Baidu’s O2O business are now included in the transaction services segment. This segment includes Qunar (a trip-booking site), “Baidu Nuomi” (a group buying service), and “Baidu Takeout Delivery.”
Thanks to the investments, growth in Baidu’s O2O business has been quite extraordinary. In the third quarter of 2015, Baidu Nuomi’s gross merchandise volume (GMV) surged 475% year-over-year. What’s more impressive is that Baidu Takeout Delivery’s GMV expanded by 12-fold year-over-year.
In total, Baidu’s increased GMV in transaction services by 119% year-over-year to $9.5 billion. (Source: “Baidu Announces Third Quarter 2015 Results,” Baidu Inc, October 29, 2015.)
So, the company has a growing O2O segment, but what about its core business? Well, on that front, Baidu has got it covered as well. Its success in China’s search engine business is bound to continue.
According to China Internet Watch, Baidu has around 70% market share in the Chinese search engine market. (Source: “Chinese Search Engine Market: Stats, Trends and Insights,” Chinese Internet Watch, last accessed February 10, 2016.) This fact alone is going to be a great catalyst for the company’s search business. Here’s why.
You see, in the search engine market, there’s something called the network effect. To put it simply, the more people using the product or service, the better it becomes. For search engines, the one with the largest market share can provide the deepest and most contextualized search results. That’s why Baidu’s future success in this segment is almost guaranteed.
As a natural monopoly, Baidu’s search engine business is tremendously profitable. EBITDA margins are as high as 50%. (Source: “Forget China’s Macro Outlook, We like ‘China’s Google’ Baidu,” Antipodes Partners, December 11, 2015.)
The Bottom Line on BIDU Stock
Moving forward, Baidu CEO Robin Li has promised to spend more than $1.0 billion a year in each of the next three years to establish Baidu’s position in the O2O market. These sizable investments could continue to weigh on the company’s bottom line.
On the flip side, Baidu’s previous investments have generated enormous growth in its O2O business. If the trend continues, it could be a huge catalyst for BIDU stock.