Big Numbers Give Baidu a Bump

Impressive earnings are sending the stock of China's leading search engine into orbit. Google and Yahoo need to move fast to share the space.

Can anything stop Robin Li? A lot of people in China are probably asking themselves that question today, following news that Baidu.com (BIDU), the country's No. 1 search engine, reported impressive earnings growth for the first quarter. Li, Baidu's founder and chairman, predicted more good times to come, helping to fuel a 23% rise in the company's stock price.

Baidu's good news comes at a time when its two main rivals, the Chinese versions of Google (GOOG) and Yahoo ( YHOO), are struggling to keep up with their high-powered local competition. Baidu commands over half (57%) of the Chinese search market, with Google controlling 18.7% and Yahoo 13.6%.

That dominance helped Baidu increase its profit for the three months through March by 143%, to $11.1 million, compared with the same quarter in 2006. Quarterly revenue also grew well, doubling to $35.7 million.

China, the world's second-largest Internet market after the U.S., provides Li and his team with plenty more room to grow. While there are more than 130 million Chinese online, that's still only 10% of the country's population. In the U.S., Japan, and South Korea, about 60% to 70% of the people are online, says Richard Ji, an analyst in Hong Kong with Morgan Stanley (MS).

'Better in Chinese'

Even more promising for Baidu, the untapped pool of potential advertisers is deep. China has about 30 million small and midsized enterprises, but fewer than 0.5% of them are Baidu customers.

That number is likely to increase at the same time that the percentage of Chinese using the Internet rises. "If you combine these, it is not difficult to see enormous growth potential in the Chinese Internet market," says Ji, who estimates that the total market for online search last year amounted to $260 million and is likely to grow by 50% to 60% compounded annually over the next three years.

Numbers like that mean companies like Google and Yahoo have to find ways to make inroads into China, despite the clear advantage Li has. But Baidu has been able to maintain its big lead thanks to its well-established brand and superior search technology, says Duncan Clark, managing director of Beijing-based consulting firm BDA China. "Baidu is just better in Chinese," he says.

The company does face some big challenges. On Wednesday, for instance, Google announced it had reached a deal with state-owned operator China Telecom to share revenue from online ads. Last month, Google announced a similar partnership with China Mobile, the dominant cellular operator, to collaborate on mobile search.

Taking a Chance on Japan

Such deals provide some hope for Baidu's rivals that Li won't be able to gobble up the whole market. "There's still a lot of potential there," says Clark.

Adds Morgan Stanley's Ji: "If you look at the U.S. market, there are two or three other search players [besides Google]. In China, there is a chance for coexistence of two or three of the major search players."

Another concern is Baidu's recent expansion into the Japanese market, its first foray beyond China. Although Google and Yahoo Japan dominate the Japanese search market (with a combined market share of over 80%), Li has launched Baidu Japan. The idea is to provide a way for Chinese businesses to reach potential customers in Japan who are interested in purchasing lower-cost, made-in-China goods (see BusinessWeek.com, 2/16/07, "Baidu Thinks It Can Play Japan").

It won't be easy for Baidu to pull this off, cautions Ji. A big problem will be costs. "Japan is expensive," he says. "Labor costs are typically 10 times higher than in China." Still, as long as business keeps booming back in its home market, Baidu is reckoning it can afford to take a chance.

Einhorn is a correspondent in BusinessWeek's Hong Kong bureau .