Google May Lose China, but Is Baidu Poised for a Fall?
Yes, Google could very well get kicked out of China for removing censorship controls on search there, and in the long run that could be a big mistake. China, after all, is the world's largest Internet market with roughly 300 million users, yet only about a fifth of the population is online, suggesting there's loads of growth to come. And although Baidu dominates search in China, with nearly 65% of the market versus Google's 30%, even the secondary position in such a vast and growing area is a lot to give up. As UBS analyst Brian Pitz told clients on Wednesday: "If Google were to exit China, we believe this would represent a significant lost growth opportunity in the long term."
In the shorter term, however, China is immaterial to Google's business, seeing as it accounts for only about 1% to 2% of revenue -- and even less than that after excluding traffic acquisitions costs, according to Jefferies analyst Youssef Squali. Pitz over at UBS figures that equates to 25 cents to 30 cents a share. Based on analysts' average forecast, China would contribute 1% to 2% of fiscal 2009 earnings per share. That means today's dip in Google shares has essentially discounted the potential loss of the China business -- and the stock still looks like a buy.
More worrisome is the huge rally in Baidu. Shares jumped as much as 15% at one point during Wednesday's session, making the valuation look pretty stretched. The stock now commands a premium of nearly 50 times forward earnings, or more than two-and-a-half times more expensive than the broader market.
True, Baidu's outsized growth warrants a fat premium to the S&P 500 ($INX) -- analysts, on average, expect compound annual growth of nearly 40% over the next five years, according to Thomson Reuters -- but the stock has a nasty habit of bouncing up against such lofty valuations and then falling hard. Indeed, shares in Baidu are nearly twice as volatile as the broader market, meaning it is perilously easy to "buy high."
Then there are some serious fundamental concerns regarding Baidu. In a nice bit of irony, Pali analyst Tian Hou lowered estimates for the company Tuesday even before the Google news broke, partly because China has shown "renewed vigor" in shutting down websites that host "unhealthy content."
By removing censorship of search, Google's taken a stand that it will no longer accommodate the communist regime. As a Chinese company, Baidu has no choice.