- Buy BIDU for value below $130 (USDCNY FX as at 26-July)
- Buy BIDU for momentum below $225 if price is rising on weekly basis (USDCNY FX as at 26-July)
Baidu is a high growth, medium volatility stock with a turnover of $500m per day. The high turnover means that its a suitable candidate for many relative value strategies ran at the largest investment funds. Capturing alpha on a daily timeframe is likely to be very difficult in the absence of serious game-changing news, and hence we’ll look for a weekly or monthly strategy.
- Chinese language internet search provider
- Current CNY revenue of 10b USD equivalent per year, 90% of which comes from online marketing
- Revenue growth flattened in 2016 (prev 20+% yoy) after increased regulation was imposed on search advertising, but most recent quarter has returned to a 15% yoy increase
- Competitive advantage is the critical mass or network effect gained from having a monopoly on China advertising services (also monopoly on data analytics)
- Operating margin is currently at 15% with likely more upside than downside:
- COO announced change in strategy in acquisitions Baidu Nuomi and Baidu Takeout Delivery from transaction services to advertising revenue
- Leading online video platform iQiyi to become the sole distributor of Netflix content in China reducing the capital required for original content creation
- Partnered with Microsoft on 18-July-2017 to collaborate on autonomous driving systems
Our valuation method is first to calculate a high-certainty terminal value per unit of revenue. Then we proceed to make an assumption as to how many years of growth the company has before reaching its mature, terminal value.
We’ve assumed that the changes in business strategy will increase the profit margin from 15% to 20%.
For a deep value strategy the key question to answer is: how many years of growth are the majority of value investors prepared to pay for? Or another way of looking at it: what premium to intrinsic value is the monopoly position in China’s online advertising and video streaming worth? For such a liquid stock there could also exist a relative value premium assigned to it due to its inclusion in highly liquid relative value trading strategies (e.g. trading Baidu vs Google and other search engines). For pure value in a falling market however, its definitely a buy @ $110 and a buy @ $135 if the monopoly premium or relative value premium is likely to hold.
A momentum strategy is likely to be more interesting because potential upside from Baidu’s business activity may still not be fully understood. Just how valuable is having the most comprehensive database of Chinese internet user activity? How valuable is being a first mover on autonomous driving technology? If there’s value in either of these propositions it should be captured using a momentum strategy. The momentum strategy is to buy when pricing is rising on a weekly timeframe with a 10% stop loss ($175 assuming constant USDCNY exchange rate). Target is a 20% gain or more ($240 share price) which could take up to 1 year to pan out.
Chart here: https://www.tradingview.com/chart/92jSVhm4/