4 Silver Linings in Baidu's Bad Quarter
If Baidu (NAS: BIDU) was trading today, it wouldn't be pretty.
The leading Chinese search engine posted mixed results on Monday night, and the top-line outlook for the current quarter is even worse.
Revenue climbed 50% to $994.6 million during the third quarter, shy of the 53% surge that analysts were forecasting. The news gets better on the bottom line. Earnings soared 60% to $478.6 million -- or $1.37 a share. Wall Street was betting on net income of $1.28 a share.
That's pretty impressive, especially when you divide that profitability by revenue to arrive at net profit margins of 48.2%. Good luck finding a stateside company cranking out margins like that. Corporate taxes will take a big bite out of even the nimblest of overachievers. Baidu is clearly benefiting from its lean and scalable model, assisted by a refreshingly low effective tax rate of 13.5%.
Unfortunately, that lower tax rate -- and a more than doubling of interest income earned -- helped boost net margins. It's a bit of an illusion, you see. Operating profits grew at merely a 48% clip, actually failing to keep up with Baidu's revenue growth.
However, the real problematic part of the report is Baidu's guidance. It now sees revenue growing by 38% to 42% during the fourth quarter, representing a slight sequential dip. Wall Street was angling for sequential improvement on a 46% year-over-year spurt.
Over the weekend, I went over four reasons why Baidu should close higher this week. That's starting to seem like a bad call, but let's dive a little deeper into where the four reasons stand in light of what we now know.
1. Baidu is still growing at a heady rate
There were a few analysts turning bearish on Baidu in recent weeks, and the challenges that they were pointing out are materializing.
Qihoo 360's (NYS: QIHU) launch of a rival search engine this summer is making an impact. If not, it's just a matter of growth in China decelerating. To be fair, it's probably a combination of both.
However, what's so bad about growing revenue by nearly 50% during the past three months and a midpoint that implies a 40% year-over-year pop during the final three months of the year? Based on Baidu's close on Friday, the stock is fetching just 18 times forward earnings. Baidu's growth would have to slow a lot more than that in order to not justify its valuation on an earnings basis.
2. Baidu has a history of surpassing expectations
Baidu had beaten Wall Street's profit targets for 13 consecutive quarters heading into Monday night's report. Well, that streak is now at 14 straight quarters.
Cynics will argue that the boosts in interest income and a lower effective tax rate handed Baidu the beat, but the streak is still impressive. The weak revenue guidance for the new quarter may raise questions about its ability to keep this streak going, but it's easier to bet for Baidu than against it on a streak like this.
3. Qihoo 360, at best, is Bing
Qihoo 360's foray into search is still a wild card. This isn't Sohu.com's (NAS: SOHU) Sogou, which has been toiling away for years on a sliver of the Chinese search market. This certainly isn't Google's (NAS: GOOG) partial surrender in China, a move that opened the door for Baidu to grow its market to as much as 80% earlier this year.
Qihoo 360 is turning heads, but will they stay that way? When Microsoft (NAS: MSFT) repositioned its search offering as Bing a couple of years ago, it did generate a fair amount of novelty interest. It's still popular, but it really hasn't eaten into Google's domestic dominance in search. My suggestion over the weekend is that Qihoo 360 will eventually plateau, especially now that it's starting to monetize its efforts.
Baidu's performance and its guidance implies that Qihoo 360 will continue to be a problem in the near term. Chinese Web tracker Analysys International recently put out a report showing that Chinese search engine operators experienced a 51% year-over-year surge in revenue during the third quarter. If it's accurate, Baidu grew slightly slower than that. Investors will want to keep an eye on how revenue growth stacks up relative to guidance this quarter.
"Mobile and cloud represent our vision for the future of China's Internet," CEO Robin Li is quoted as saying in Monday night's earnings release.
"In the quarters ahead, we will look to accelerate the pace of investment to achieve long-term, sustainable growth," CFO Jennifer Li adds.
This may seem like little more than lip service. After seeing Facebook's (NAS: FB) stock take off last week after painting a positive snapshot of mobile growth, you can bet that other dot-coms will follow suit. However, the CFO's comments should rattle investors. She's essentially saying that Baidu's margins -- and its bottom-line growth -- may suffer as the company throws money at mobile and cloud initiatives.
Baidu has a lot to prove, again, but what else is new?
Betting on China
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The article 4 Silver Linings in Baidu's Bad Quarter originally appeared on Fool.com.Longtime Fool contributor Rick Aristotle Munarriz has no positions in the stocks mentioned above. The Motley Fool owns shares of Baidu, Facebook, Google, and Microsoft and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Baidu, Facebook, Google, Microsoft, and Sohu.com. 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.
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