Wednesday, March 26, 2008's Poetic Struggle (BIDU) is an Internet Information Provider, founded in 2000 and based in Beijing, China. The name ‘Baidu’ was derived from a poem written about 800 years ago during the Song Dynasty. ‘Baidu’ means searching for something over and over and over. In the poem though, the search revolves around a beautiful female who lost or abandoned her love. The poet describes the search for her as frantic, making it the goal of his dreams through life's many difficulties. We sense that Mr. Li, the founder and current President expressed more than what's in an average Corporate name when he chose ‘Baidu’. Mr Li deserves great credit for his guts and genius in staring up and operating his company in China: his conviction and spiritedness is reflected in his voice in the conference calls.

Before the analysis begins, we want to give our respects to BIDU's late CFO Mr. Shawn Wang, who tragically passed away only three months ago.

BIDU provides Chinese language internet search services. BIDU's Initial Public Offering (IPO) debut was on the Nasdaq 8-04-2005. The lead underwriters were Goldman Sachs and Credit Suisse (CS First Boston today) and Piper Jaffray was listed as co-underwriter. The initial price range was $21.00-23.00 with 3.7M shares offered, but the deal was over subscribed, "hot" as they say, and ended up pricing 4.04M shares at $27.00. BIDU closed up 354% at $122.54 in its first day of trading! One of our team members placed over 30 IPO's while at Morgan Stanley from 1997-2001, so we called upon him and his expertise to scrutinize the BIDU IPO and the ramifications going forward.

BIDU's shares have a 52 week range of $92.80-$429.19. As of its March 24TH close at $240.00, BIDU's shares are up 159% from their 52 week low and down 44% from their high of $429.19, on November 6, 2007. We labored through many man hours of IPO data, conference call analysis, accounting metrics, competitive advantages & disadvantages, technical analysis, public articles/stories, as well as geo-political issues, both for and against BIDU. We avoided an exhaustive write up of all of the above data points, but we offer enough information to enable you to trade BIDU with greater conviction. After analyzing the fundamental data using our proprietary trading microscopes, we weighed the many intangible components accountants often miss. Here's our Psychological trading Call on BIDU.

The most common statistic quoted by most of the BIDU bulls relates to demographics: 1.3B Chinese, a market that is only 10% penetrated, and BIDU has a 60% commanding market share over its rivals GOOG, SINA, and SOHU. The number of Chinese internet users is tied with the U.S. at 155M, but the bulls argue that when the rest of the 1.3B consumers come online, Baidu looks like it has the ‘green pasture’ that Wall Street dreams of finding. Are bulls correct in going long because of these demographics?

Thomas Malthus would argue against the bulls. His 1798 "Essay on the Principle of Population" is still studied and cited by economists and sociologists. Malthus argued: "The pressure of large populations tends to depress wage rates to subsistence levels and keeps them there, with the excess population being eliminated by war, pestilence, or starvation". ( Could this 210 year old theory apply to modern day China? We hope not, but our readers should be aware of the inherent problems that very large populations could face.

In a piece written on Monday March 24TH, a Motley Fool contributor stated "I am a believer in Chinese growth stocks" and pointed to today's price of only 37X next year’s earnings. We have to question whether the harsh regulatory environment, mounting inflationary pressures, Shanghai Index down over 40%, and recent geo-political tensions with Tibet warrant a 37X forward P/E. How about 30X P/E, which translates into $195/share, or 25X P/E = $162/share. We also question whether the 2008 Beijing Summer Olympics caused advertising revenues to rise to ‘bubble’ levels, and if that's true, what happens if the growth estimates that bulls are using turn out to be too optimistic for 2009?

Yes. Disaster.

The shares would fall to reflect a completely different denominator/profit; so going long based on a forward P/E in an environment filled with geo-political uncertainty is irresponsible in our opinion. Only rarely should you buy a stock based solely on fundamental analysis. To the credit of the Motley Fool writer, he does point to geo-political tensions in his piece, but his prior write ups missed that component and we’d rather not have to piece together someone's thoughts from several articles to understand how they truly feel.

As always our goal is to give you a look at the entire picture from ‘top down’ to ‘bottom up’. ‘Top down’ analysis refers to researching the macro geo-political and economic environment a corporation finds itself in, and "bottom up" analysis targets specific companies from their core first, not factoring in the macro risks. We strongly believe a ‘top down’ analysis must be understood before committing to buying any Eastern asset, especially in China. Perhaps Jimmy Rogers' argument for the commodities bull market in China makes sense, but every market tops out eventually.

Let's turn to the 46th minute of the Q4 2007 conference call (CC), streamed on February 13th, 2008. ( Analyst Robert Peck asked what turned out to be the best and hardest question: "What happens if there's a global consumer recession". Mr. Li answered, "I'm not an economist". He later defends BIDU as insulated and with market share leadership. Ironically, Robert Peck was employed at Bear Stearns at the time. We give Robert credit for asking that forward-looking question, and ask our readers to follow Robert's career; we definitely will as forward thinking analysts are rare. Listen to this exchange and you'll detect the relevance of the Psychology of the Call. At the 3 minute 17 second mark Mr. Li attributes BIDU's recent successes to growth in advertising from large "financial services".

The recent 40% pull back in the Shanghai Index cannot help this metric in the current quarter as many large financial Institutions are looking at eroding balance sheets due to stock depreciation, which will likely crimp advertising campaigns. When an Index falls 5% or 10%, or even 15%, that’s considered a "healthy correction." When an Index falls more than 20%, in the Shanghai case 40%, that’s classified as a "bear market."

A bear market ahead of the biggest commercial/advertising event in China's history? Unfortunately that's a fact!

Lastly, at the 15 minute 10 second mark, BIDU guides their revenues down for Q1 2008, citing severe snow storms and the Chinese New Year. Remember the 4th Commandment: never accept excuses from management. What will happen on the next quarterly CC when management must address the bear market as well as recent Tibetan unrest? Will BIDU say the advertisers may tighten their belts because the Chinese government may ban live footage from Tiananmen Square? Have you any idea of the effect this would have on ad revenues? So please don't be fooled by Motley's mention of 37X next year’s earnings. In other opinion the Summer Olympic months ahead may well present incredible operating challenges.

Here’s where we see the biggest hurdles for BIDU: 2009 may seem light years away for shareholders if the Chinese government stumbles and falls. Unfortunately, the government still has a lot to say in regard to human rights and freedoms and here's where Mr. Li's genius lies in choosing the name Baidu. "'s Poetic Struggle" in China is well documented and cannot be addressed by accounting. Forecasting China is more of an art in our opinion, like a poem perhaps, but definitely not an exact mathematical science like accounting.

In September of 2007, BIDU launched a proprietary online Olympic news site. The shares climbed from $200 to their 52 week high of $429.19 within 2 months. No doubt this was correlated to optimistic anticipation of the Olympics. Most of the Olympic hype and premium has since eroded, but is the erosion complete? Ironically, BIDU's 52 week high of $429.19 was printed the exact month they launched Baidu Finance Online, a site focused on stock prices, market news, and accounting data. But maybe that was just coincidental; maybe our next example is the true reason BIDU has fallen 44%.

Five months ago, the Chinese government was accused of cutting off the ability of U.S. search engines to operate, allegedly redirecting traffic to Baidu. Should any world government be involved the operations of a public corporation? Although this is fundamentally positive for BIDU in the short run, it reveals the lack of freedom in Chinese corporations. Perhaps BIDU's market share would not be at 60% if government allowed true competition. In addition, could the fiery growth rate of BIDU be cooled down in the future by the same government that fans the flames today? That is the type of "top down" analysis we want you to embrace along with the fundamental accounting data. Never trade on growth estimates without weighing the psychology of the geo-political environment. Emerging markets are called "emerging" for good reasons. They differ from ‘developed’ markets in that developed markets exist under more ‘efficient’ democracies, and therefore greater human freedoms and rights.

China was irked by an award that the U.S. bestowed upon the latest Dalai Lama, a Buddhist spiritual leader, in a succession that coincidentally dates back to the 1300's, the same time as the Song Dynasty and the inspiration for the poetic name Baidu. The poetic struggle in finding freedom comes full circle here, and the Baidu name now takes on more meaning than a simple Corporate name. It is a symbolic name. Baidu represents the search for that ‘beautiful’ freedom (over&over&over&over); we sympathize to a great extent with the brave Chinese people and the obstacles they still face. ( No democracy should limit 1st Amendment Rights, but many BIDU bulls continue to offer forward estimates in the face of a dangerously controlling government. Politics in money and banking is a pressing issue even in the U.S (please read our prior piece “One Wounded Bear and Two Gov't Officials Wake Up the Bulls"). But the "politics" in China are of a more dangerous and potentially virulent nature. We refuse to take sides to what is an ancient conflict with Tibet, but we sympathize with the Tibetan Buddhists as well.

BIDU is facing a Shanghai bear market, rising inflation, rising interest rates, a government controlled economy, and an Olympic Games in danger of not being televised. The reason many bulls bought BIDU shares over the last two years had to do with their optimistic view of a successful Beijing 2008 Olympic Games; that optimism is eroding fast. On Tuesday France's Nikolas Sarkozy threatened to boycott China's biggest Olympic moment. Only today the European Union urged China to handle the uprising in Tibet with restraint and to avoid volence, while the Belgian government refused to rule out a boycott.

In considering all of the above it's our opinion BIDU shares have a higher likelihood of trading down to the $150.00 level before breaking through $300.00.

We urge our readers to avoid BIDU until we get a sense of how bad the current operating environment actually is. That will be addressed on the next CC, which you know we will cover in great detail for you.

Lastly, Mr. Li's struggle is in the perfect poetic tradition. Wikipedia states that "The poetic tradition is a line of descent of poets who have achieved a sublime state and can surrender themselves to their work in order to create a poem which both builds on existing tradition and stands on its own". We hope BIDU will one day be able to finally achieve "standing on its own", without any help… only the poetic freedom it deserves one hundreds times over ~


Anonymous said...

I think the blog is brilliant. Please keep informing me on the inter workings of politics and money, I know it exists.

Anonymous said...

Good analysis. Looking forward to reading on your post earnings analysis.