Doubting to shuō

Here’s the mid-2007 update for my portfolio. All the quotes are from the close of June 1, 2007. As usual, I’m not posting my IRA investments.
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(Note: This post’s title has hurt some feelings. It was not intended to refer to any specific blogger. In particular, Lonnie at OMB is actually a very generous person in his charity work. This post is an argument against an idea, not an individual.)

Recently, it seems there’s been a sort of obsession spreading through the expat blogging communities. It’s about search engine optimization, i.e., trying to get one’s site to come up as high as possible in search engine results. The idea is to bring in traffic by figuring out how the search engines rank sites and then exploiting that system, or at least making sure of not being ranked artificially low. It’s not really a topic I’m interested in, but I’ve been dragged into this debate. Now that I have, I’ll let let my feelings be known.
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The major downside of taking on my current entrepreneurial project is the money that I’m not making any more. This pain has been further compounded by the fact that the stock I’ve been wanting to buy has grown by over 30% in the last two months.
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With all the talk on my blog and others about search engines in China, it’s only fitting to post the market share and popularity rankings for 2005. Baidu is the clear leader, and Yahoo has lost quite a bit of popularity.

In related news, Baidu’s Q3 year over year revenue growth was 173%.

I just remembered a really neat thing about Bǎidù. Remember how you used to be able to get MP3′s straight from a search engine? On Chinese search engines you still can. Go to http://www.baidu.com, click on the MP3 at the top, type in the name of the song you want and go.

This second picture has the various search terms labelled in English. Baidu will let you choose what filetype you want to download: .mp3, .ram, .wma, etc… There’s also a lyrics search, and the functionality to hear a sample before downloading the whole thing. It’s the most convenient way to download music I’ve ever seen.

I guess I should warn my readers in the US, the penalties for downloading songs this way could be worse than those for arson, auto-theft, assault, battery, or even manslaughter. With the RIAA successfully suing thousands, including children, it needn’t be said that some things in the US are seriously messed up right now. But hey, in China there’s already more freedom in a lot of regards. If you are American and any of this bothers you, consider contributing to the EFF or the ACLU.

Update: The timing of this is amazing. A grand total of three days after I published this post, Baidu started blocking searches for US songs. Sorry for getting your hopes up everyone.

At this point, just about everybody who follows the stock market at all has heard of Băidù, the Chinese search engine company whose shares rose from $27 to $150 on IPO day, setting a NASDAQ record. This same company’s site http://baidu.com is currently the 5th most visited site in the world. On top of that, the name Bǎidù supposedly comes from some nifty, classical Chinese poem. However, analysts are nearly universal in their critique that Bǎidù is over-valued. Goldman Sachs initiated coverage on Bǎidù last month with an “underperform” rating, valuing the dominant Chinese search engine at $27 a share. The market on the other hand, still values it at about $67 a stub at the time of this writing.

In this post, I’ll investigate two things:

1) What poem exactly did the name Bǎidù come from anyway?
2) Is the valuation fair? Should I invest in it directly or maybe just pursue indirect ownership through shares in google?

The Name

After sniffing around on baidu.com itself, I turned up this interview with the founder. (Those of you who can’t read simplified characters might like this tool.) After that, it didn’t take too long to come up with the original poem by 辛棄疾:

青玉案

東風夜放花千樹，更吹落、星如雨。
寶馬雕車香滿路。
鳳簫聲動，玉壺光轉，一夜魚龍舞。

蛾兒雪柳黃金縷，笑語盈盈暗香去。
眾裡尋他千百度。
驀然回首，那人卻在，燈火闌珊處。

The man was desperately searching for his loved one in a festival. In the red line above you can see the word 百度 bǎidù appears to be an intensifier. I’m no translator, so I’ll just go word by word:

In the crowd, I searched for her a with an intensity of a thousand-hundred degrees.

Or maybe like this: In the crowd, I searched a million faces (and didn’t see hers).

I can understand how this name would convey the intensity of their baidu.com’s search for your information, but is this really the image they should give users? Would anyone really want that kind of searching experience? You search a million times in failure, only to find what you were looking for later after you already gave up. It makes a good love poem, but if there must be something about the Chinese psyche I seriously don’t get if those connotations make for an appealing search engine name.

The Valuation

Let’s start by looking at their revenue and income for the last 3 years:

Financial Performance

*Through 6/30/2005; revenue and net income in millions. Data from Capital IQ and Baidu.com SEC filings.

That revenue growth is nice. However, it is clearly decelerating. It’s not easy to keep up %50 growth for more than a few years. Looking at these numbers Baidu’s (Nasdaq:BIDU) current valuation of over 2.1 billion dollars looks absolutely insane. Let’s say we assume that BIDU remains a fast growing stock worth a P/E of 40 even after five years. What would earnings need to be to justify a market cap of 2.1 billion? The answer is, somewhere around $54 million per quarter. This would be to achieve zero growth in the market cap. I don’t know about you guys, but I want to see a good chance for at least a 20% yearly growth to even touch risky growth stocks like this one. In order to achieve that earnings would have to be as follows.

This means that if Baidu were to receive a generous P/E of 40, it would have to grow earnings from it’s current 3M by 213% per year every year for five years. Looking up at the my first chart you’ll see that it isn’t even growing at that rate now. It seems pretty clear that Goldman Sachs knows what they are doing. Until you look at the history of similar companies when they were making similar earnings, that is.

Data provided by Capital IQ.

Google needed to get 4 times larger than Bǎidù’s current size before it was profitable. Yahoo had to get even larger than that to become profitable. While Bǎidù’s valuation of 2.1 billion is outrageous by traditional metrics, consider this: Yahoo is capitalized at 46 billion, or about 20 times what Bǎidù’s is. It’s only been nine years since Yahoo was earning 21.5 million, just like Bǎidù is now. Yahoo was losing money then, and Bǎidù is not. Just five years ago Google was earning what Bǎidù is now, and doing so at net losses. Google is now capitalized at 92 billion, or about 46 times what Bǎidu is.

Bǎidù is certainly run more efficiently than its predecessors. Not only that, but it is pursuing a MUCH larger market. The growth of China’s entire GDP has been triple that of the US for decades, and the differential in computer usage uptake is even greater. On top of all of that, tax burdens are MUCH lower in China than in the US.

Just as I’ve made very profitable investments in the past by ignoring the advice of wall street, I plan to do so again. The major firms have research at their disposal that individual investors couldn’t hope to match, and yet their “buy ratings” have underperformed the market consistently for decades. Searching a million times does no good if you’re searching in the wrong place .

Legal Disclai
mer: I own stock Amgen, and Middleby. I previously owned but do not currently own Apple. As of the time of this writing I do not own any interest in Yahoo or Baidu.