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

200220032004LTM*
Revenue$1.3$4.7$13.4$21.5
Revenue Growth238%185%60%
Net Income($2.2)($1.1)$1.5$3.0
Net Income Growth100%

*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.

YearMarket
Cap
P/EEarnings
Need to Be …
Today$2,15040$53.5
2006$2,58040$64.5
2007$3,09640$77.4
2008$3,71540$92.9
2009$4,45840$111
2010$5,35040$134

This means that if Baidu were to receive a generous P/E of 40, it would have to grow earnings from its 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.

CompanyYearRevenueNet Margin
Google2000$19.1 million-76.9%
Google2001$86.4 million+8.1%
Yahoo!1996$21.5 million-29.8%
Yahoo!1997$84.1 million-51.6%

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.

CompanyYearRevenueProfit
(Loss)
Eventual
Market Cap
Yahoo!1996$21.5($6.4)$46 billion (9 years later)
Google2000$19.1($4.3)$92 billion (5 years later)
BaiduTTM$21.5$3.0???

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.