Bearish Baidu Bets Sink to Seven-Year Low on Mobile Push

The cost of hedging against losses in Baidu Inc. has dropped to the lowest since 2007 on speculation China’s biggest search engine will boost sales as it pushes into mobile devices.

Puts protecting against a 10 percent decline in Baidu’s American depositary receipts cost 0.1 point less than calls betting on a rally of the same magnitude 6yesterday. The gap fell to negative for the first time in seven years on July 3, data on three-month contracts compiled by Bloomberg show. ADRs have risen 39 percent from this year’s low reached April 7.

Analysts have increased their estimates for Baidu’s second-quarter sales since February as the Beijing-based company, which represents three-quarters of search queries made from desktop computers, is aiming to replicate that dominance with China’s 500 million mobile-Internet users. Research firms from Pacific Crest Securities Co. to JG Capital said Baidu may post second-quarter results higher than analysts’ average projections thanks to rising mobile-search traffic.

“The company is executing well on its strategy to get their search application on most smartphones in China,” Walter Price, a senior portfolio manager at Allianz Global Investors, which manages $493 billion in assets, said by e-mail yesterday. “That is encouraging investors to expect better results as we go forward and Internet traffic growth comes mostly from mobile devices.”

Higher Estimates

The options price relationship known as skew reached a negative 0.6 point on July 3. ADRs of Baidu, whose second-quarter report is due July 24, rose 0.8 percent to a record $199.27 as of 9:50 a.m. in New York. The Bloomberg China-US Equity Index climbed 1.9 percent to 110.58 in a third day of gains.

Analysts have raised projections for Baidu’s second-quarter sales by 14 percent over the past six months to an average 11.9 billion yuan ($1.9 billion), data compiled by Bloomberg showed. That would represent a 58 percent increase from the company’s revenue a year earlier. Baidu may also provide higher-than-projected guidance for third-quarter sales, according to Henry Guo, a San Francisco analyst at JG Capital.

Baidu expects mobile searches to surpass personal computers as the biggest source of search traffic later this year, Chief Executive Officer Robin Li said in April. The company spent at least $2.5 billion on six acquisitions last year to maintain its lead among China’s Internet companies. In August, it paid $1.85 billion for app store 91 wireless as part of its mobile strategy.

Alibaba, Tencent

Other Chinese Internet giants are also increasing their presence in the search market. Alibaba Group Holdings Ltd., China’s biggest e-commerce operator, last month fully acquired UCWeb Inc., a browser maker that set up a joint venture to offer searches on mobile devices. Tencent Holdings Ltd., the nation’s largest Internet company by market value, invested in Inc.’s search unit in September. Qihoo 360 Technology Co., a Beijing-based browser company, started a search service in 2012.

While Qihoo accounted for 16 percent of online queries in the first quarter and Sohu’s Sogou search held 5.1 percent, they remain well behind Baidu’s 76 percent share, according to data compiled by Bloomberg.

Baidu’s push into mobile devices and infrastructure means that, despite surging sales, it won’t see a profit boost this year, Chief Financial Officer Jennifer Li said on an earnings call Feb. 26. Adjusted net income may have risen 5.2 percent to 2.9 billion yuan in April-June after jumping 26 percent in the prior quarter, according to the average estimate of nine analysts compiled by Bloomberg.

Marketing Expenses

Baidu is trying to pre-install its search app on mobile phones, a measure that the company calls “essential” in getting users to try new apps. Pre-installations represented the majority of Baidu’s marketing expenses, management said Feb. 26.

“Investors are growing a little bit more concerned about companies that are so aggressively investing that we’re seeing adverse impacts on things like operating margins,” Scott Kessler, an analyst at S&P Capital IQ in New York, said in a phone interview July 11.

There’s increasing optimism that profit margins will improve in 2015 as the cost of pre-installing its apps is expected to slow, according to Cheng Cheng, an analyst covering Chinese Internet companies at Pacific Crest in Portland.

Baidu’s sales growth has accelerated due to increases in advertising income on PCs and mobile devices, as well as incremental revenue from acquired businesses, Morgan Stanley analysts led by Philip Wan said in a note yesterday. They raised the recommendation on the stock to a buy equivalent from hold, lifting the price target by 32 percent to $239.30.

The company’s leading position in desktop searches means it will be difficult to challenge it significantly in mobile, 86Research Ltd. said in a note July 17. Advertisers aren’t allocating more funds to Qihoo as they believe it doesn’t have enough mobile search queries, 86Research analysts wrote.

“Baidu still dominates the space through PC and mobile platforms,” 86Research said.

Before it's here, it's on the Bloomberg Terminal.