Baidu Inc (ADR) Risk Factors: Brand Strength

By Markets Fool.com

Baidu is the dominant Internet search company in China and has done a wonderful job of fighting off competitors both domestic and international on the way to becoming a $71 billion company by market cap. In China, Baidu must fend off local competitors such as Qihoo and Sohu. It's also expanding its reach globallyinto other large markets such as Brazil --where it recently launched a Portuguese version of its search engine -- where it will more directly face off with Google , which currently owns 88% market share of global search.

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Key to remaining strong at home and expanding abroad is for Baidu to make its brand more known and respected by Web users.

In the company's latest annual report, management lists a handful of potential threats to the business. One stood out to me as being particularly difficult to solve. "Our business depends on a strong brand, and if we are not able to maintain and enhance our brand, our business and results of operations may be harmed." Strong brands give a company pricing power. Brand powerhouse Coca-Cola, for instance, is able to deliver tremendous returns on equity because consumers are willing to pay significantly more for a Coke product than an otherwise similar product from a generic producer.

Strong brands also help ensure loyalty from consumers when presented with other options. In the United States "Googling" has become a verb meaning searching for information in a search engine. Even with other options such as Bing, Yahoo, and others, Google remains the dominant search engine in the United States. Google is responsible for about 64% of U.S. searches.

Measuring the power of a brand is not an exact science, but analysts at Forbes have put together a list of the 100 Most Valuable Brands in the world.Google, the company that Baidu is most often compared to, comes in at No. 3 with a "brand value" of $65.6 billion. Baidu doesn't crack the top 100.

However, Baidu had about 56% percent market share in China as of late 2014 and has historically had very enviable margins. These margins have, after reaching a peak of 50.77% in June 2012, dipped all the way to 19.25% in March 2015. This dip has caused its margins to drop below that of Google, which currently boasts a profit margin of 20.78%. Expansion into other lines of business such as online video with Shanghai-based PPS, and a daily deals site called Nuomi, which are allowing Baidu to diversify its revenue streams, may have caused a short-term hit to marginsand it remains to be seen what they hold for the future of the company.

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Google built itself from a search company into one of the world's largest and most respected companies by leveraging its brand and the cash flows from its core search business into Android, Maps, Gmail, and myriad other products and services. Baidu also is looking to grow.

Robin Lee, Baidu's chairman and CEO, in announcing the financial results for the first quarter endedMarch 31, 2015, wrote, "Baidu'splatform is comprehensive and robust, and we plan to fully exploit the huge growth potential ahead -- in mobile marketing, online to offline, and key select verticals such as health care, education and financial services -- by leveraging our solid mobile foundation, exceptional technology advantage, and proven operational experience."

Baidu is a strong company that dominates search in the world's most populous nation. In the previous quarter it generated nearly $400 million in net income on over $2 billion in sales. While Qihoo 360 managed to garner 29% market share in China in 2014, up from 10% the previous year,Baidu remains a good bet. Internet penetration in China remains around 50% and a growing overall pie should allow multiple search businesses to flourish.

Key to Baidu continuing to flourish in China, expanding into new businesses, and reaching outside China's borders is keeping the Baidu brand strong and boosting its value. Doing so will make future product rollouts easier as an entrenched base of consumers will be more likely to trust the Baidu name when it comes to health care, education, financial services, etc. Baidu's goal should be to become the Coke to the rest of China's generic store brand. If it can achieve this, margins will be resuscitated, more of the top-line growth will flow to the bottom line and this Chinese giant can turn its attention to even more new areas for growth.

The article Baidu Inc (ADR) Risk Factors: Brand Strength originally appeared on Fool.com.

James Sullivan owns shares of Apple and Baidu. The Motley Fool recommends Apple, Baidu, Coca-Cola, Google (A shares), Google (C shares), and Sohu.com. The Motley Fool owns shares of Apple, Baidu, Google (A shares), and Google (C shares) and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.