Baidu, Alibaba.com, Smiling At Google’s Stance

On January 13, Google announced that it is considering shutting down its Chinese operations if it cannot reach an agreement with the Chinese government over censorship policies; Google wants to run its search engine without filtering results, which it is required to do under Chinese law. Google also said that it has been the target of cyber attacks that it suspects were from China. Google has been steadily losing market share to Baidu, China’s homegrown search engine and the leading Chinese-language search provider, since the former’s entry into China in 2006. According to a recently published report by UBS, together Google and Baidu control 90% of search revenue and 95% of search traffic in China. Baidu is estimated to have 62% of Internet search revenue and 74% of search traffic in China.

If Google does pull out of China, then Baidu, which has a close relationship with the Chinese government, is likely to become a monopoly with even greater bargaining power over its advertisers. Along with Baidu, other Chinese Internet companies like Alibaba.com (which owns Yahoo China) should also gain more acceptance at the expense of foreign Internet companies, since local businesses may start doubting the tenacity of these international Internet companies and prefer to play it safe by going with local companies.

One of the most prominent of these is Alibaba.com (1688.HK), an e-commerce company that operates three online marketplaces: a global trade marketplace for importers and exporters, a Chinese marketplace for domestic trade in China, and, through an associated company, a Japanese marketplace that facilitates trade to and from Japan. Together, the company’s marketplaces form a community of more than 45 million registered users from more than 240 countries and regions. Alibaba.com also offers business management software solutions targeting small businesses across China under the “Alisoft” brand. The amount of traffic to the company’s site has grown rapidly; Alibaba’s global traffic ranking was 110 in December 2009, according to Alexa.com.

Alibaba.com declared its Q309 results on November 10, 2009. Total revenue in Q309 was RMB1,032 million ($151.2 million), up 32% Y-o-Y and 12.3% Q-o-Q, driven by accelerated customer acquisitions and yen appreciation. Non-GAAP profit from operations was RMB312.5 million ($45.8 million) in Q309, down 20.2% Y-o-Y and down 4.3% Q-o-Q, mainly due to planned voluntary investments. Net income in Q309 declined 20.4% Y-o-Y to RMB236.0 million ($34.6 million) due to continued investments in customer acquisitions, people, and technology to position the company for future growth. Deferred revenue was up 42.1% Y-o-Y and 7.4% Q-o-Q to RMB3 billion ($434.6 million).

The company’s paying membership grew 45.3% Y-o-Y and 8.9% Q-o-Q to a total of 578,901 paying members as of September 30, 2009. In Q309, Alibaba.com added around 2.5 million registered users, 558,000 storefronts, and more than 40,400 paying members to its marketplaces. Combined marketplaces had 45 million registered users, representing 27% Y-o-Y growth and 6% Q-o-Q growth. The company had 6 million storefronts representing 46% Y-o-Y growth and 10% Q-o-Q growth.

Revenue from the international marketplace increased to RMB639.3 million ($93.6 million) in Q309, up 33.7% Y-o-Y and 11.2% Q-o-Q. Net additions of China Gold Supplier members in Q309 were 14,415 to close at 84,868, up 175.2% Y-o-Y and 20.5% Q-o-Q. The international marketplace surpassed 10 million registered users, up 51.6% Y-o-Y and 10.8% Q-o-Q. In the international marketplace, the number of storefronts reached 1.2 million, representing an increase of 41% Y-o-Y and 9% Q-o-Q.

There was a decline in order size in the international marketplace, but buyers have been buying more frequently. In response to this, Alibaba.com has developed AliExpress, a wholesale transactional platform to facilitate small bulk transactions online.

Revenue from the China marketplace was RMB378.3 million ($55.4 million) in Q309, a 28% increase Y-o-Y and a 13.4% increase Q-o-Q. By the end of September 2009, the China marketplace had a total of 34.8 million registered users and 4.84 million storefronts. The number of China TrustPass members grew steadily, with 33,623 net additions in Q309 for a total of 475,422, up 34.9% Y-o-Y and 7.6% Q-o-Q. The wholesale online transaction platform has seen healthy growth in the China marketplace, with more cross-platform correlation in terms of developments and promotions between Alibaba.com and Taobao.com.

Alibaba.com has been investing in customer acquisition to drive market leadership, which it believes will drive future revenue growth. With the acquisitions of HiChina and Alisoft, the company has made significant investment in a new customer base and e-commerce applications. The two acquisitions strengthen the company’s portfolio of services (business management software and other infrastructure services) and improve its capability to deliver value to its customers through a SaaS model. Alibaba.com has also been investing in brand-building exercises in its major overseas market, which has proven effective in drawing users and traffic to its marketplace.

Alibaba.com has proven that its business model is stable and to a large extent protected from the economic downturn and slowing exports in China. With the economic outlook improving, I expect Alibaba.com to do much better since its investments in customer acquisition and technology should start to bear fruit. Increased focus on customer service and the adoption of value-added services like Ali-ADvance and premium placement should also drive growth.

The stock is trading at $19.20 Its 52-week high of $22.50 was reached on September 8.

Baidu, Inc. (NASDAQ:BIDU) announced its third quarter results on October 26, 2009. Total revenues in Q309 were RMB1,278.7 million ($187.3 million), up 39.1% Y-o-Y. Operating profit in Q309 was RMB521.4 million ($76.4 million), a 41.6% increase over Q308. Net income in Q309 was RMB492.9 million ($72.2 million), up 41.7% Y-o-Y. EPS for the third quarter of 2009 was RMB14.14 ($2.07). As of September 30, 2009, the company had cash, cash equivalents, and short-term investments of RMB4.0 billion ($580.8 million).

Online marketing revenues in Q309 were RMB1,278.2 million ($187.2 million), representing a 39.2% increase from Q308. Baidu had about 216,000 active online marketing customers in Q309, representing an 11.3% increase from Q308 and a 6.4% increase from Q209. Revenue per online marketing customer in Q309 was approximately RMB5,900 ($864), a 25.5% increase from Q308 and a 9.3% increase from Q209.

Traffic acquisition costs (TAC) as a component of cost of revenues were RMB196.2 million ($28.7 million), representing 15.3% of total revenues, compared to 11.8% in Q308 and 16.0% in Q209. The Y-o-Y increase in TAC as a percentage of total revenues reflects the continued rapid growth of Baidu’s Union business while the sequential decrease reflects normal fluctuation.

During the quarter, the company saw large customers shift more of their marketing budgets to Baidu’s P4P platform. Phoenix Nest, Baidu’s new online marketing system, continued to gain customer traction and showed promising results in key monetization metrics, such as coverage and cost-per-click trending upwards. As of September 30, 2009, 70% of Baidu customers were using Phoenix Nest. Revenues from Phoenix Nest contributed over 20% of total revenues in Q309.

Baidu is trying to create a more efficient online marketing ecosystem for its customers and partners, from which it expects to benefit over time. In this effort it has launched Baidu Statistics and Site Manager. Baidu Statistics is an advanced tool that allows customers to track and analyze site traffic in order to optimize their online marketing campaigns and increase ROI. Site Manager is a tool for partners to manage their inventory on their own sites.

On January6, Baidu announced its plan to establish a new independent company to provide licensed online video to Chinese Internet users. The new company will work with content providers to provide copyrighted premium video content, including movies, TV shows, sporting events, animation and other content through an advertising-supported model. With China’s Internet industry evolving and demand for online video rising, this could be another winner for Baidu, if it is able to leverage its search platform and execute on its model.

Baidu expects moderate Y-o-Y growth in Q409 due to the temporary negative impact it anticipates when the Online Marketing Classic Edition is discontinued. Baidu currently expects to generate total revenues in an amount ranging from RMB1,190 million ($174 million) to RMB1,230 million ($180 million) in Q409, representing 32% to 36% Y-o-Y growth.

As for the online video content move, it is a good one, though it comes a bit late in the day. But success will depend on Baidu’s ability to execute. The mobile search tie-ups with China Unicom and China Telecom could also be big as mobile search gains momentum. Baidu seems to be poised for growth and is investing in its engineering and sales capabilities, and branding efforts, which I believe will enable it to continue to grow in the coming quarters. But the key element of success will obviously be Baidu’s ability to execute, and execute well.

The stock has moved up sharply in the two days following Google’s announcement, from $387 on January 12 to over $464 at market close on January 14. But even if Google decides to continue its operations in China, Baidu should benefit since advertisers will be cautious about Google, and I expect to see the company continue to grow in the coming quarters.