China's Baidu.com's Bubble Already Deflating

By Riva Richmond, Of DOW JONES NEWSWIRES

NEW YORK -(Dow Jones)- Baidu.com Inc.'s (BIDU) bubble has already deflated remarkably, less than three weeks after its U.S. stock-market debut.

The Chinese Internet search engine's shares soared 354% to $122.54 on their first day of trading on Aug. 5, a rise that, for some, triggered uncomfortable memories of the late 1990s go-go days. The stock's ascent, which peaked at $ 153.98 during the second day of trading, revealed investors' ongoing love affair with Baidu's much larger U.S. cousin, Google Inc. (GOOG), and outsized hopes for China's consumer class and budding Internet industry.

But the enthusiasm is already waning. Baidu's Nasdaq-listed American depositary shares are worth half their Aug. 8 peak value, based on Wednesday's closing price of $77.80. The decline has erased about $2.3 billion of Baidu's market capitalization.

Of course, Baidu is still valued at about $2.4 billion, a number that strikes many market watchers as exorbitant for a company that posted just $7.9 million in revenue for the second quarter. As such, some think the stock has quite a bit further to fall.

"The tape tells the story. The stock got up to a wild first-day ride we haven't seen in about five years," says John Fitzgibbon, an analyst with IPO desktop.com. "As the circus moved out of town, the realities started to settle in. What you've got is an unseasoned stock looking for a level. And where are the seasoned investors at these levels?"

Indeed, Baidu had all the elements of a rocket ship, even in today's more cautious Internet-investing environment. Its business mirrors Google's, and it is well positioned to expand along with the vast and booming Chinese consumer market. Meanwhile, the offering came with a small float that left eager investors scrambling for shares.

"Everybody saw this as son of Google," and held fast to the "flawed" notion that "anything that is Chinese just naturally has to be a winner," says David Menlow, president IPOfincial.com.

But Baidu's market opportunity and growth trajectory remain hard to predict, considering the nascent state of China's Internet industry and the government's penchant for controlling media use there. Moreover, competition for the Chinese market is gathering in intensity, with rivals like Google and Yahoo Inc. (YHOO), which is now in partnership with local firm Alibaba.com Corp., stepping up expansion there.

The potential stumbling blocks seem to be tempering investors' calculations about just how fast Baidu can grow. In fact, Baidu's stock closed down $4.20, or 5.1%, Wednesday after the company issued a restrained third-quarter revenue forecast of $9.6 million to $10 million, up 151% from a year ago but up only 19% from the second quarter. Baidu also reported net income rose sevenfold to about $1.5 million in the second quarter.

Baidu's shares recently traded at $78.68, up 88 cents, or 1.1%, on volume of 2.4 million shares, compared to average daily volume of 6.4 million shares.

Despite the stock's decline, it still carries a rich price tag. Wall Street analysts, now in a 30-day quiet period, haven't yet issued earnings or revenue forecasts for the company. But a generous assumption of $35 million in revenue this year, and double that in 2006, implies a valuation of about 30 times 2006 revenue.

Internet companies tend to trade at large revenue multiples because of their high profit levels, but that multiple is out of sight even compared to Google, which trades at less than 10 times Wall Street 2006 revenue estimates. Google, which posted second-quarter net income of $342.8 million on revenue of $1.38 billion and is growing at a tremendous clip, has seen its stock triple in value since it went public about a year ago.

"I don't think we have bubble-itis here," Menlow says. "People are taking a momentary step off of the sanity ledge" by trading Baidu 188% above its $27 offering price, he says.

Whether other market players agree is somewhat hard to gauge. One common measurement tool is short-seller interest, or the number of shares investors have lent out in bets a stock's price will decline. But under Securities and Exchange Commission rules, it is prohibitively difficult to short stocks within 30 days of a company's initial public offering, thus short-interest numbers aren't yet available.

"As an investment over the next 12 months, you might be better off with a Google or Yahoo," says Martin Pyykkonen, an analyst at Hoefer & Arnett Inc. Their valuations are more reasonable and, because they're geographically diversified, carry less risk.