“We prefer buy to build,” Baidu (BIDU) Chief Executive Officer Robin Li said of the premier Chinese search engine’s growth strategy during an analyst call last month. On Tuesday, Li put those words into action: Baidu announced that it is spending $370 million to buy the Internet video business of PPS Net and merge PPS with its own online video operation, iQiyi.com.
The deal will leapfrog Baidu ahead of rival Youku Tudou (YOKU) to make it the top online video company in China, the company says. It already enjoys Google-like dominance of the Chinese search market and doesn’t have to worry about competing with Google’s YouTube (GOOG) because Chinese censors block access to the U.S. company’s online video service.
Baidu could use a boost. After years of impressive growth,the company is slowing down as Chinese Internet users shift away from PCs to smartphones and tablets. On April 26, Baidu reported that net income for the first quarter had increased 8.5 percent. Not bad, unless you compare the result to the average growth over the previous five quarters—64 percent. The quarterly net income of 2.04 billion yuan ($331 million) was 6.8 percent below analyst estimates.
The picture won’t be getting much brighter for Baidu in the near future. “With substantial margin contraction ahead, earnings growth will likely be muted,” Brean Capital analysts Fawne Jiang and Long Lin wrote in an April 26 report. Baidu’s ADRs have dropped 31.5 percent in the past 12 months, compared to a 59 percent increase for Internet security company Qihoo.com (QIHU), which last summer launched a rival search engine, adding to pressure on Baidu.
For Robin Li, that means the No. 1 spot is becoming more expensive. Baidu’s traffic acquisition costs amounted to 10.2 percent of revenue in the first quarter, compared with 7.8 percent a year earlier, and analysts Ma Yuan and Gu Xinyu of Bocom International expect the total to hit 13 percent by the end of the year. That would put Baidu back to where it was before Google withdrew from the market in 2010, helping Baidu solidify its dominant position in Chinese-language search.
The PPS Net deal is part of Baidu’s response as competition heats up and its traditional PC-based search business becomes less attractive. Baidu isn’t the only Chinese heavyweight looking to diversify by moving into new businesses. On April 29, e-commerce powerhouse Alibaba Group announced a commitment to invest $586 million for an 18 percent stake in Weibo, the Twitter-like service owned by Chinese portal Sina (SINA), with an option to increase the holding to 30 percent. Tencent has 300 million users for its WeChat instant messaging app and is looking to launch entertainment services for smartphone and tablet users.
With PPS Net, Baidu is trying to catch up. “Alibaba beat Baidu to the punch with its social-media acquisition,” says Praveen Menon, an analyst with Bloomberg Industries in Hong Kong. Alibaba, Baidu and Tencent (700:HK), the three most powerful companies in Chinese cyberspace, all have similar game plans, Menon adds. The Big Three are in a “race to control the mobile ecosystem,” he says. “These companies need to transition their platforms to grab consumer eyeballs on mobile devices to maintain ad revenues while also diversifying to non-ad streams such as mobile commerce, gaming, and content sales.”