BEIJING -- Heading into what looks to be a strong earnings season, investors are warming up to China's tech names that lost ground this summer. Internet portal Sohu ( SOHU) kicked things off last week by beating expectations with a 29% revenue gain. On Tuesday after the market closes in New York, search engine Baidu ( BIDU) is expected to deliver sales improvements of similar heft. Just in the past week, a handful of high-profile names have vaulted on rosy expectations for the third quarter. Between Oct. 23 and Oct. 30, shares of Sohu popped 12.3%, Baidu rose 9.9%, and Tom Online ( TOMO) jumped 16.2%. On the wireless front, the market has now had time to digest a slew of earnings warnings related to the
regulatory overhaul in China. In fact, Sohu's wireless-services business fared better than expected, though the company chalked that up to its own execution rather than any easing of the new rules. Taking a long-term view, it's worth noting that Chinese policymakers are constantly fine-tuning the rules, and regulatory changes are "part of the landscape of doing business in China," says Andrew Lee, a Shanghai-based Internet and wireless consultant. That said, analysts are still shying away from wireless services. They're far more enthusiastic about advertising plays, which are benefiting from the ongoing shift of ad dollars from print to the Internet, plus a corporate appetite for promotions tied to the Beijing 2008 Olympics.
"We're heading into what should be strong end-of-year results," says Citigroup analyst Jason Brueschke. "More importantly, the outlook for the Chinese market in general is looking more positive in '07 than in '06, especially the advertising-based models." Brueschke says now "is a good time for people to be looking at some of the higher-quality names." He has buy ratings on Sohu and Focus Media ( FMCN), which operates an ad network using flat-panel displays in elevators, buses and supermarkets. Indeed, just last week Sohu delivered up record brand-advertising revenue of $21 million, up 35% from last year's levels. Baidu is another bet on the growth of China's ad market, as more and more small businesses are willing to pay for its sponsored searches. Thomas Weisel analyst Leah Hao wrote in a recent research note that Baidu could post quarter-over-quarter revenue growth in the mid-30% range, modestly above the high end of its guidance for 25% to 29% sequential growth. In Beijing and other top markets, Hao says, her checks suggest that the renewal rate among Baidu's customers (as high as 90% to 95%) is above that of second-ranked search firm Google ( GOOG), with 85% to 90%, and No. 3 Yahoo!'s ( YHOO) 80%. Baidu has a lock on China's Net-savvy college students and is now making inroads into the white-collar professionals that have traditionally been Google's stronghold in China, according to recent reports from China IntelliConsulting, a private firm, and China Internet Network Information Center, a state information-gathering group.
Baidu's market share is now estimated at more than 60%, compared with 20%-plus for Google. However, Baidu's valuation still scares off analysts. Hao has a peer-perform rating on the stock, noting the shares were recently trading at nosebleed levels of nearly 53 times 2007 earnings estimates. Last month, Brueschke upgraded Baidu from a sell to a hold rating. However, he's not prepared to recommend investors buy the stock. "The valuation is absolutely priced for perfection, so any type of trip-up
could cause the stock to drop sharply," he points out. On the flip side, how investors react to a good showing from Baidu should indicate whether the newfound affection for China's tech sector can be sustained.