A Second Look at Baidu

 | Jan 09, 2013 | 10:00 AM EST
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Last February, I thought it was too soon to bid adieu to Baidu (BIDU).

After that article, the stock tacked on 12% and almost hit my $160 price target. But by May, the stock began a slow 34% decline. Is it time to buy, or is the stock going lower?

As you recall, Baidu is China's largest search engine and the sixth most trafficked website in the world. Like Google (GOOG) in the U.S., Baidu holds a commanding lead in Chinese search. But cracks are emerging.

At the time, analysts and investors were concerned about Chinese accounting and unsustainable margins. Other worries were rising competition and Baidu's dependence on large advertising customers.

Unfortunately, those concerns turned out to be real. Margins, for example, peaked in fiscal 2011 at 78.7%. In the next three years, margins are likely to decline into the mid-60s as the company takes more ad business from less profitable small advertisers.

Revenue growth is also slowing. Like margins, revenue growth slowed from 90% to something in the mid-20s. Revenue growth has slowed as domestic competitors keep taking market share.

Operating income is headed down as well. Operating margin peaked at 56.2%. Operating margins are under attack because research and development spending as a percent of revenue is rising from 9.9% to 13%, as the company is forced to increase spending to develop new products.

Slowing revenue, margins under pressure and increased spending to fend off competition mean only one thing: a lower stock price. If I'm right, Baidu's stock multiple is in the process of getting crushed. The stock will probably fall into the low $80s before it finds any kind of valuation support. If you haven't bid adieu to Baidu, I suggest you do.

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