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Eroding Growth Prompts Response From, Inc. (ADR) (BIDU)

Baidu (BIDU)China’s leading search engine, Inc. (ADR) (NASDAQ:BIDU posted mixed results for the fourth quarter and full year. Baidu attributes this decline to China’s weak economy, greater competition in search engine industry, and consumers shifting from desktop to mobile.

Baidu’s quarterly revenue increased by 41.6% to $1.017 billion, while annual revenue rose by 53.8% to $3.58 billion. Quarterly income increased by 36.1% to $448.7 million and by 57.5% annually to $1.68 billion. Online marketing revenues, which make up the backbone of Baidu’s business, were $1 billion, up 40.8% from Q4 2011. Annual revenue growth was in-line with total top line revenue growth.

In my previous article, I identified new sources of competition for Baidu, and its impact became even more apparent in the last reported quarter. Since Google Inc (NASDAQ:GOOG) left China in 2010, Baidu dominated the search engine industry in the country. Baidu once had 80% of the Chinese search engine market; however, the share has shrunk to 60% due to competition from Inc. (NASDAQ:SOHU) and Qihoo 360 Technology Co Ltd (NYSE:QIHU).

Revenue growth from Baidu’s search engine has slowed down at an alarming pace for the unbridled growth story the stock had surrounding it this time last year, from 82% in Q4 2011 to 42% in Q4 2012. On the other hand, costs are increasing much more quickly, which is putting a downward pressure on margins. Content costs and bandwidth costs used to be less than 5% of total revenue (Q4 2011), and now they comprise 7.2% of total revenues.

Considering the 420 million Chinese mobile Internet users who also make up 75% of all Internet users of the country, Baidu has invested $370 million in 2012 on R&D as it aims to increase its earnings from the growth of mobile and cloud technologies. Out of this, $112.6 million was invested in Q4 2012 alone.

Sohu touched the $1 billion annual revenue mark for the first time as its quarterly revenue increased by 22% YoY to $299 million. Sohu has made investments in video sharing and other technologies that are aimed at long term growth. The company reported adjusted earnings of $0.73 per share, significantly more than analysts’ estimate of $0.53 per share. Sohu’s online gaming, mainly through its spinoff, Changyou.Com Ltd (ADR) (NASDAQ:CYOU), was the real growth engine for it with revenue of $159 million (up 29%). Sohu’s search engine, Sogou, saw revenues climb by 78% to $41 million and now contributes ~14% to Sohu’s revenues.

But the real threat to Baidu’s dominance in search comes from Qihoo, as this company caters to mobile platforms in which Baidu has struggled to find its way, having nearly squandered a two year advantage on its competition. Qihoo 360 has been successful in grabbing 10% of the search engine market with the help of its mobile search facility in less than six months.

Qihoo is primarily an antivirus software firm that stepped into Baidu’s territory. While Qihoo has increased its search engine market share, this has prompted a response from Baidu – its $2 billion in cash reserves burning a hole in its proverbial pocket. It is preparing to acquire Kingsoft Internet Security (KIS), China’s third leading antivirus company. A KIS acquisition also gives Baidu ownership of Kingsoft Mobile Defender, Cheetah Browser, and Kingsoft Security Defender. Baidu addresses a number of issues with the acquisition of Kingsoft, not the least of which is stunting Qihoo’s growth in virus protection. The company is also anticipating working with other device manufacturers on voice, music and facial recognition software to be integrated into its mobile platform. Baidu is also strengthening its online video website “iQiyi’ and online travel integration website ‘Qunar.’