Baidu Needs to Fight Back

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Baidu (NAS: BIDU) is under attack by a familiar foe -- and thankfully history is on the side of China's leading search engine.

An unflattering expose by state-owned China Central Television is alleging that Baidu is still letting fraudsters game its system and that advertisers are being charged for leads that never materialized.

If these knocks sound familiar, it's because stateside giant Google (NAS: GOOG) has been hearing similar complaints for ages. Big G has to perpetually tweak its page-ranking algorithm because savvy SEO (search engine optimization) specialists find ways to leapfrog over more worthy websites. Content-farm operator Demand Media (NYS: DMD) felt the sting of Google's reranking wrath earlier this year.

Click fraud? Well, that's a battle that Google profits from, but it has no choice but to police to keep its integrity in check. Besides, advertisers know that not every lead will be legitimate, and that gets priced into how much they're willing to bid on select keywords.

The knocks on Baidu are different, but the plot is the same: Everyone loves to hate the one on top.

Opportunistic investors will remember when China Central Television had a scathing expose on Baidu running ads from unlicensed medical companies three years ago. The news nearly drove the stock down to what would be the single digits today on a split-adjusted basis. We all know the story after that. Shares of Baidu have been a 14-bagger since bottoming out after the Nov. 2008 report.

Analysts began lining up on both sides of the debate. Skeptics feel that the news will hurt Baidu's credibility with advertisers. Bulls argue that yesterday's 5% share-price dip is overblown.

Here is what we do know: Baidu advertisers continue to spend more on Baidu. Online marketing revenue climbed 78% in its latest quarter, even though Baidu's active marketing customers only grew by 17% to 298,000. In other words, the average lead seeker through Baidu is willing to send a lot more money to the company now than a year ago.

Will every click be legitimate? No. Advertisers know that every newspaper reader won't see their print ads. Commercial makers know that many couch potatoes won't be paying attention. Yes, online advertising is different because sponsors are paying per click, but it all adds up in the end. The beauty of online advertising is that it's instantly accountable. If 20% of a site's leads are bogus, the marketing customer will simply tweak its bids so that the campaign makes fiscal sense. The incentive to clean things up -- if possible -- is that it should increase the price per lead.

What critics are forgetting is that there is no legitimate alternative to Baidu. It commands more than 80% of the country's search queries. Turning to smaller players in China including Google and Sohu.com's (NAS: SOHU) Sogou for cheaper leads is smart, but an advertiser can't thrive without the top dog.

The allegations in 2008 were harsh, and Baidu wasn't the only one that stumbled. However, history shows that advertisers learn to live with the imperfect search engines because it's better than old-school alternatives or leaning entirely on the fringe players.

Baidu will bounce back, just as it has before.

How badly will this new CCTV expose sting Baidu? Share your thoughts in the comment box below.

At the time this article was published The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of Sohu.com, Baidu, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.Longtime Fool contributor Rick Munarriz has only been to China once, but he relishes admiring its dot-com revolution from afar. He does not own shares in any of the stocks in this article. He is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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