Value drivers for Baidu
Since its inception in January 2000, Baidu has grown to assume the position of the leading internet search company in China by traffic, the largest internet portal in China, and the fifth ranked in the industry by 2005. Its growth and dominance can be attributed to several factors, such as its heavy investment in research and development (R&D). The company developed Chinese language processing search techniques.
The company’s understanding of the Chinese consumers and advertiser needs made it differentiate itself from its competitors. Baidu was the first internet company in china to use a P4P (pay-for-performance) model on its advertisers. The P4P model was favored by both advertisers and search engines since it allowed for more transparency on return advertising expenditures. The auction based bidding system that was subsequently introduced enabled advertisers to compete with each other for link placements, until a maximum price is reached, to the benefit of Baidu.
Where search companies like as Google and Yahoo modified their global products to fit the Chinese customers, Baidu uses its knowledge of the local market by developing products unique to the china. The company has been leading in innovation, such as the introduction of the MP3 search capability, in the process gaining market share. The multi-tiered distribution model employed by Baidu enables SMEs to advertise in specific regions in which they operate. Google’s lack of cooperation with the Chinese government means that Baidu still has the opportunity to capitalize in the market. Since the founders of the company are Chinese nationals, Baidu is able to enjoy a large user base since the company is perceived as a national brand. Baidu’s early entrance in the market meant that it could establish itself firmly among the first internet users.
China’s internet users have been increasing at a fast and steady rate, in pace with the growing economy. Growth in business has seen companies spending more on advertising. Online advertising is increasingly becoming more popular than traditional media in China, which means that internet companies such as Baidu have a great opportunity to grow their services and revenues. Rising income levels in China have increased the demand for various goods and services, thereby improving the online advertising market for internet companies like Baidu.
Stock exchange choice for Baidu
Given the choice to pursue an IPO, Baidu should choose to list its shares on NASDAQ, which is based in the United States. If Baidu was registered in China, then a local stock exchange would have been appropriate.
Factors to consider
A company should consider several factors when it’s choosing a stock exchange for listing, such as size of the company, volatility of its stock, the company’s industry classification, motives of the founders or venture capitalists and requirements of the stock exchange. Baidu could not float its shares on Chinese exchanges such as Shanghai or Shenzen because the company was not registered in china. NASDAQ is also suitable for relatively new companies, and offers a form of prestige to technology companies. There are more financial analysts covering NASDAQ quoted companies, hence shares are likely to be highly volatile.
Advantages and disadvantages of listing on NASDAQ
A great feature derived from trading on NASDAQ by both companies and investors is that the stock can be traded for longer hours, than traditional stock exchanges. NASDAQ international opens for trading six hours before the New York Stock Exchange (NYSE), corresponding with the opening time of the London Stock Exchange (LSE), and closes half an hour before the NYSE opens (Sharpe 2008).
Companies listed on NASDAQ are mostly high-technology companies, which are all regarded to have a high growth potential, and receive better valuations in traditional metrics, such as the price-earnings ratios. Investors in NASDAQ are more willing to risk their investments on new technology companies. Owners of companies willing to list their companies on NASDAQ can take advantage of SEC’s Rule 144, which allows stock holders before an IPO to sell restricted stock in certain proportions after the IPO date (Anderson & Dyl 2008).
A disadvantage of listing on NASDAQ is the high compliance costs involved, and high potential litigation costs. Since NASDAQ is heavily weighted by technology companies, the index that measures the performance of stocks listed therein tends to be volatile because of the speculative nature of those companies.
Implications of the discounted cash flow method and the comparable multiple valuation model
A company can be valued in a number of ways, one of which is the discounted cash flow (DCF) method. DCF calculates the present value of a company by discounting the future earnings, or cash flows. The weighted average cost of capital is mostly used as the discount rate so as to derive the present value of a company or an investment. The method is quite simple and effective, but it has a few disadvantages.
The future cash flows used are merely approximations; hence the model will not give an accurate result. Rates used are also subject to change over the long-term, which implies that the figures are to be reviewed on a regular basis so as to maintain relevance. The DCF model is also affected by small changes in data used, whereby slight alterations might result in huge changes. Since it is quite difficult to ascertain that cash flows will remain unchanged over the long-term, terminal figures are often used; therefore only simple results can be achieved from the DCF model. (Stanford Graduate School of Business, 2009).
Using the DCF model, Baidu’s value would be equal to the present value of its future revenue streams, using an appropriate discounting factor such as the country’s prevailing interest rate or the weighted average cost of capital (WACC) (Berman, Knight & Case 2008).
Business risks for Baidu going forward
The main challenges for Baidu come from its competitors, both local and international. International competitors Google and Yahoo! have more capital at their disposal which means that they can invest more in R&D. the technologies industry is very susceptible to changes in innovation, where even the slightest of changes can make previous products and services obsolete. Local companies, such as Sina and Sohu, have been in the Chinese market for a longer period of time than Baidu, hence they may have a better understanding of the local situation. Should the two companies streamline their operations and become more effective, then they stand a chance to regain some of the market share lost. Yahoo! has made a strategic alliance with Alibaba.com, which will undoubtedly intensify competition for Baidu.
Baidu’s business model is associated with some faults as well. The P4P model ranks advertisers and content based on the auction process, rather than the relevance of the information. There was also no clear distinction between adverts and search results, so users first have to go through sponsored links in the search results. This might cause the search engine to be unreliable due to biasness, and hence lose a significant proportion of their users. A slowdown in China’s economy will slow down Baidu’s revenue growth due to decreased spending by its clients. Government censorship programs in China may lead to restricted information; hence Baidu will not be in a position to provide quality services to its clients and users. (Sharpe et al 2008).
Baidu has lesser index size than Google, where it displays almost 700 million websites compared to Google’s 3.2 billion (exhibit 12). A lesser index size may make Baidu inferior in service delivery since it offers only a limited range of information. Baidu should increase the size of its website index if it to effectively compete with Google. Baidu also faces tax challenges, should the Chinese government decide to withdraw tax incentives to the technology companies.
Baidu’s Union members, who are important in driving the search engine’s traffic, can terminate their contracts with the company at any time, so there is uncertainty about performance with partners, and ultimately, future revenues. The company should also review its policies on images and MP3 music, should the government decide to enforce intellectual property rights which might bring about legal complications and expenses for the company.
Anderson M. A. & Dyl E. A. (2008). IPO listings: where and why? moneywatch.com / The Economy Publications / Financial Management. Manhattan, NY: Cengage.
Berman K., Knight J. & Case J. (2008). Financial Intelligence for entrepreneurs: What you really need to know about the numbers. Cambridge, MA: Harvard Business School Press.
Sharpe W. F., Alexander G. J. & Bailey J. V. (2008). Investments. New Delhi: PHI Learning.
Stanford Graduate School of Business (2009). Baidu.com, Inc.: Valuation at IPO. Case no. A – 197, 2/5/09. NewYork, NY: Stanford University Press.