Wednesday, October 26, 2005

Baidu's Outlook

Baidu reported earnings after market close on Oct. 26.

The management was very upbeat on the conference call held later.

We are growing more confident about Baidu's future for several reasons.

1. One main negative thing in the past was the MP3 controversial in which Baidu has lost to Shanghai Push on one lawsuit. Baidu's management insist on keeping it as a free search service and claimed it neither store MP3 files nor providing download services and Baidu does not receive any payment from either the users or the third parties.

Many legal experts predicted also Baidu would lose a bigger case where several largest music labeling companies filed lawsuit together against Baidu. The reason was based on politcal concerns(Chinese courts are still very much subjected to political pressure). If Baidu wins, the whole western world will all cry foul on China(maybe rightfully) on IPR piracy that would make a not-quilty verdict impossible.

If Baidu shuts down MP3 service, the consequence will be severe. Baidu derives about 20% of revenue from MP3 service by showing advertisement on every page that leads to a third party download link.

In recent days, Baidu has been moving on both fronts. On the defensive, Baidu has been trying to negotiate with the parties involved and so far less fruitful but slightly warming up. Baidu has followed court instructions by placing an addtional interphase page with IPR warnings between Baidu pages and the third party downloading page in hope to limit potential damage claims if the case lost in the future.

On the offensive, Baidu has signed agreement with HURRAY and started a new song releasing service last week for a Chinese movie super star turned pop star. The deal struck hard on the labeling companies because Baidu's MP3 service has in fact are quite helpful for them. If a song ranked high on Baidu's MP3 search, the service providers often come and stuff "stacks of cash" to the song distributer's pocket. In certain sense, Baidu's MP3 has become de facto ranking service for songs.

Many smaller players have already in constant contact with Baidu on MP3 alliances. Many internet experts also predicted that it is an irreversible trend that digital music will be distributed digitally through internet. Baidu's huge audience is also too attractive to be ignored by music distributors.

Baidu just started a new service called "Grand Music Alliance" or The page looks just great. It shows a picture of an singer with an album list with trial listening links as well as links to fans' bulletin board and news. Each page looks just like the home page of the singers. It's a dramatically better site with user friendly experience than Yahoo's music site where graphic rich advertisements occupying half of the page.

What everybody would agree is that Baidu's MP3 search is the best in the world and many music distributors are not willing to be shut out of Baidu's MP3 search completely. What many of the these "greedy" (Steve Jobs called them) companies in mind is probably trying to get a bigger share and force Baidu into negotiations with them for paid services.

We do not forsee a result of complete shut off of Baidu's MP3 service. Baidu may choose to drag on the case in appeals until the grand alliance getting bigger and stronger, then the other players will have no choice but to succumb. The internet users have demanded to access digital music digitally and no one will be able to refuse that. There are also more than enough singers in China are willing to join Baidu's music alliance soon. If they can also grab a few popular western singers to release a few new songs on Baidu, that would be the end story for music labeling companies. It is pretty much similar to Google Print situation.

2. Google's competition

The largest threat is of course coming from Google. Google's competition started a few years ago when they hit hard on Baidu around 2002 with it's Chinese search service. But Baidu came out as the winner through a hard fought battle with the legendary "lightning plan".

Since three months ago, Google finally started to push into the Chinese market. They have announced three channel partners in China for ad services. They hired Kai-Fu Lee away from Microsoft to be its CEO of China operations and later hired Johnny Chou as president for sales and marketing development. In September, Google succeded in joining the free but vast CERNET in which Google was excluded in the past. No one can underestimate the power of Google.

However, a few months past, we have not seen significant inroads made by Google. At least not yet. Baidu's traffic rating went up one notch to the number 4 in the world on Alexa's ratings. There are several complicated reasons behind that.

One is that Google is still hesitating to have a server farm set up in China in fear that a government filtering of contents could hurt Google's brand.

The result is that Google has no effective Chinese news service where Baidu has become the strongest player in China. As revealed by CNNIC survey, the majority of users access internet in China for news. And the majority of news accessed are entertainment news.

We have not yet seen Google's Chinese news service even it started Chinese search many years ago and we don't expect Google to chllenge Baidu's position any time soon. As long as we don't see any dent on Baidu's market shares in Chinese search in significant terms, Baidu's future remains very bright.

Baidu's strategy is to win by sharply focused on Chinese search. The management think only by doing that, Baidu can be unbeatable because Chinese is only 5% in Google's index. By that measure, Google needs twenty times more effort in updating it than Baidu's.

After Baidu's recent upgrade of it's data center, we have indeed seen significant difference in Baidu's search results from Google's. Baidu's search results are much more updated and faster(ave. 0.01 second vs 0.5 second). Baidu's results are mostly upto the moment while both Google's and Yahoo's can be one to two years old.

Another drawback for not having servers located in China is that the cross-pacific bottleneck has slowed down many sites in China by Google's ads. We have seen many complains on network slow down and the warm reception for Baidu Union, an Adsense-like service from many bulletin boards. The service started three months ago and so far only attracted some small sites. We have not seen significant presence of them in more popular sites. Baidu's management indicated in the conference call that they would put more effort in pushing the Baidu Union services.

Another attractive part of the Baidu Union is easier and faster to get paid than Google's Adsense. Baidu has signed ICBC and China Merchant Bank as payment service providers. The two banks owns more than 50% market share of online payment services in China.

We have also seen many reports mentioned that college students are moving from 100% Google to 50% Google and 50% Baidu. Previously, CNNIC reported that higher income internet users tend to use Google more. We think it is a slightly mis-interpretation. The real reason is probably more depending on the English level rather than income level since higher English level is closely associated with higher income level. On Chinese searchs, people definitely prefers Baidu in a large margin. Baidu's management also mentioned today that more Chinese are satisfied with Chinese only searches.

On the commercial market, we have not seen significant presence of Google's advertisers after a few months. Even search for hot keywords such as car or music, you still don't see any ads appears on Google's search page yet.

As more and more people are "google it" in other parts of the world, "Baidu Yixia" is planting deep roots in China. The trend will be harder and harder to reverse. Our analysis does not see how Google's taking over Baidu as the largest Chinese search service in short term and probably in many years as long as Baidu stays as focused as they are now.

As long as this situation not be changed in significant way, we predict a strong pick up in Baidu's revenue continuing the trend in last two quarters. Multi-nationals are eager to gain access to China's gigantic and fast growing consumer market and they are putting more money in advertisement and more and more of that are going into search engines. Baidu as the largest Chinese search engine will be the first beneficiary of this tidal wave. Since almost all of their products are already Chinese-branded, there is not much need to put those in English searchs.

Indeed, many of these companies are already Baidu's customers. We have seen dramatic increase in ads from eBay, Dell and other US companies on Baidu recently. Many companies such as Intel, Cisco, Dell, even IBM are deriving somewhere from 10% to 30% of their revenue from Chinese market. It is reasonable to expect that they will spend more and more on Baidu. We are also seeing many ads from automanufactures such as GM as well as consumer giants such as softdrink and coffee makers and P&G.

Baidu has also been able to come up with comparable and sometimes better product offerings from Google such as Adwords, Adsense, and desktop search. Baidu's is performing much better than Google's groups. or "Baidu knows" is also gaining grounds rapidly and could be a huge magnet for internet users.

In a fast growing economy and evolving search engine market, Baidu is up in the front. With many tallented and devoted employees from the number one and number two colleges in China with a similar Silicon Valley culture as Google's, we can expect to see Baidu to become one of the greatest Chinese company or maybe one of the greatest one in the world.


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