China–Soon The World’s Search Engine Capital

Baidu (NASDAQ: BIDU), the most used search engine in the largest internet market in the world, has come of age. The company will be larger than Yahoo! (NASDAQ: YHOO) in a year, at its current growth rate, and much more profitable. Baidu’s second quarter numbers showed revenue of $528.4 million, a 78.4% improvement from the corresponding period in 2010. Net income was $252.6 million, a 95.0% increase. Yahoo!’s revenue in the second quarter was down 5% to $1.128 billion. Net income was up 11% to $237 million.

Baidu’s shares moved higher by 6% on the news to an all-time high of $166. The stock is up over 300% in the last two years.

Baidu was something of a toy to Wall St. just three years ago. The Chinese company’s revenue was only $239 million in 2007, which made it a small internet company by almost any U.S. standard. China was the world’s largest internet market even then. Investors reasonably raised the question of why Baidu was not a much bigger operation if the Chinese opportunity was so significant. That is no longer an issue now.

What the markets will have difficulty forecasting is what Baidu’s revenue will be three years from now. China had 450 million internet users as of the middle of this year. That is 50% more people than the entire U.S. population. The count could easily top 600 million within the next few quarters as a larger portion of the rural population moves to cities. Baidu will then have a much larger potential user base than Google (NASDAQ: GOOG) has in its core markets of North America and Europe. Google’s inability to get market share in the People’s Republic has been well-chronicled. Google’s world is no longer getting larger because most developed nations have high penetration of internet use. Baidu’s world still expands at an astonishing pace, particularly because China’s online market is so large already.

Investors are often stunned when they see that Baidu’s market capitalization is $58 billion. That is over three times Yahoo!’s and nearly 30% of Google’s.

Google had revenue of $9 billion in the last quarter, up 32%. Net income was $2.51 billion, an increase of 36%. Wall St.’s concerns that Google is only in one business were allayed by the strength of these figures, which were almost entirely from search advertising. Google’s core business is obviously still a powerhouse. But that is only true within a relatively small number of highly developed nations. Google does not have deep roots in China, Russia, or India.

The world’s largest search market will never be a significant one for Google. It pressed as hard as it could to gain customers in China and was turned back by loyalty to the local product and skirmishes with the Chinese government over censorship and online privacy. That is why Baidu’s market value is likely to approach Google’s. And it will happen soon if Baidu continues to double its revenue each year.

Douglas A. McIntyre