Baidu May Not Be a Bargain Yet

Investors who are tempted by Baidu's beaten-down stock price would be wise to take a step back.
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Behold the


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backlash. And it couldn't have come at a worse time.

Backlashes happen. The bigger the spotlight, the stronger the backlash.


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felt it when sellers arranged boycotts to protest new policies.


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got it bad when its "don't be evil" mantra was flung back in its face.

They both toughed it out, albeit with a few bruises and scratches. The Baidu backlash looks much worse. The stock rose 15-fold from its 2005 IPO price of $27, hitting $429 a year ago. Now it's back down, hanging just above the $100 mark. The company is facing a series of setbacks and lawsuits just as the global recession is threatening its ad revenue.

Investors who are looking for bargains to emerge in Asia before they do here might be tempted by Baidu's beaten-down stock price. They should think again.

The latest blow to Baidu came Friday, when Goldman Sachs (which has an investment banking relationship with Baidu) issued a note that drove Baidu's stock down 5% to $109.10 Friday. Goldman analyst James Mitchell fretted that not only are some advertisers bidding less, but consumers may start clicking less on sponsored links. Following a short-lived rally Monday, the stock was down again Tuesday, dropping 7.3% to $109.36.

"Baidu's revenue may be more performance-driven than other China media but less performance-driven than search engines elsewhere because many of its advertisers use search to support brands rather than drive online transactions," Mitchell said.

That's a crucial distinction because advertisers strongly prefer performance-based targeted ads over brand-building ads, like



banner ads. Baidu may be falling behind Google's algorithms in terms of uniting searchers with the links that could result in a transaction.

Google has worked hard to compete in China. Its link-suggest feature, which automatically offers several searches when you start to type, was developed with Asian users in mind. It's harder to type search terms in Chinese characters than in our alphabet, so Google believed users in China were less inclined to use search.

Another analyst, Jason Helfstein of Oppenheimer (which makes a market in Baidu shares) identified another difference between Google and Baidu: Baidu doesn't distinguish sponsored search results from so-called natural links served up by the search engine. But it may need to start doing so, pushing some of the sponsored links to the second or third page of search results, where they would be less visible.

That would mean reducing paid clicks at a very bad time. Two weeks ago, a Chinese news program busted Baidu for running ads from unlicensed health companies. Baidu agreed to stop running the controversial ads, but it was a pretty good business for them -- between 10% and 15% of its revenue.

The unlicensed medical ads may have marked the culmination of the Baidu backlash, but it may not represent its end. Other ads for things like lottery tickets could also be questioned. And it could face lawsuits, from investors and others, if charged with violating advertising laws.

Baidu is no stranger to lawsuits. It recently won a high-profile one brought by seven major music labels who alleged Baidu engaged in the illegal downloading of their copyrighted music. But it's facing other lawsuits, reportedly including one from an advertiser claiming Baidu

manipulated its search results


More worrisome, dozens of companies are

mounting a case

against Baidu's business practices, which allegedly involve blocking companies that don't bid on sponsored ads from its search results. To address those concerns, Baidu may need to separate sponsored links from natural ones, hence the risk of lower revenue.

Scandal and speculation has been dogging Baidu for months. When infant formulas and powdered milk were tainted with toxins, rumors emerged that Baidu was censoring information critical of advertisers. No evidence has emerged that that was the case, and Baidu repeatedly denied it. But the opacity of its relationships with advertisers allowed the rumors to linger.

And in September, other Internet companies like

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blocked Baidu's Web-crawling spiders from indexing data on their sites, concerned that fraudulent sellers might manipulate the results. Taobao said at the time it didn't object to its listings being crawled by search engines, but that "traffic coming from Baidu was of low quality" and led to few sales.

All of these incidents paint a broader picture of a company increasingly tainted with missteps. And they raise a larger question. What does China's government, long a big supporter of Baidu, make of it? If bureaucrats turn cold on Baidu, the worst may be yet to come.

So while some Chinese stocks may be close to a bottom, and while Baidu appears historically cheap, it may be too early to say it's a bargain. Until the scandals, lawsuits and advertising model are worked through, it might be better to consider the No. 2 search engine in China, which could benefit if Baidu loses market share.

That company? Google.