Before bouncing back nearly 10% from its recent lows, Baidu’s stock has taken it on the chin as of late and I wanted to do a run down of the events. We’ve had some decent gains in this position since we initially added it and we’re up nearly 10% on the part we nibbled last week. But this is long-term investment that I’d like to see triple or more in coming years, so let’s analyze what could make that happen.

Much of the negativity surrounding Baidu of late is because of a worthy adversary Qihoo360 just launched a search engine of their own.

Much of the negativity surronding Baidu is because of a worthy adversary Qihoo360 just launched a search engine of their own. From the Wall Street Journal:

Chinese Website Qihoo Pushes Google Aside

Google Inc. GOOG -1.39% faces intensifying challenges in China after a popular website and Internet browser company there replaced the search service for its own technology.

Qihoo 360 Technology Co. QIHU -0.43% launched its own search engine last week and is in the process of making it the default on its website and browser, said Chief Financial Officer Alex Xu in a Tuesday interview. The Beijing company, whose Internet browser reached about 270 million monthly users in the first quarter, previously offered Google’s search technology as the first choice.

Qihoo’s move underscores the uphill battle Google faces to penetrate a market dominated by domestic rivals, including Baidu Inc., BIDU +1.02% which holds 78.6% of the search market in the second quarter, according to industry research firm Analysys International.

Qihoo360 actually missed their numbers the same day but the hype around the announcement drowned that out.  While it’s nice for Qihoo360 that they are turning on a revenue stream, selling Baidu on the news reflects  deep misunderstanding of the Chinese internet market.

So let me say this as clearly as I can: Baidu has so much sheer traction in China that being long the Baidu ecosystem is the best way to bet on China.

What is undeniable and is going gangbusters for Baidu is traditional search. They maintain a commanding 78% + of the market.  From the excellent Enfodesk Analysis:

Search dynamics are the same in China, India, Bolivia, Estonia and the U.S..  Old habits die hard.  I have yet to meet the person under the age of 40 who uses Bing (real anecdote, one of my analysts was recently hanging out with a rapper who appeared in a Bing ad.  When he asked why he was using Google instead of Bing the rapper replied “They already paid me and that s**t doesn’t work”).  And even if you come up with a better search algorithm, the cost for indexing is pretty high.  Baidu has a tremendous amount of stickiness going for it, a concept we’ll come back to.

Where Baidu has lagged is mobile.  But they are moving aggressively to correct that and I think their strategic partnership with Sina is doing much better than most analysts are giving it credit for.  From Chinadaily:

Baidu, China’s biggest search engine company, will also install Sina’s Weibo micro-blogging service on software for mobile devices, the companies said in a joint statement on Tuesday,without giving a schedule. The alliance covers collaboration on content and data as well, the companies said.

In case you don’t know microblogging is HUGE in China.  Twitter users might be quoted on CNN’s crawl but ordinary microbloggers in China are superstars.  Sina’s microblogger user base is about 300 million, roughly the population of the United States.  Microblogging is another sticky service, users are unlikely to switch even if another service offers something better, because that means foresaking your reputation and follower count and starting all over.  That’s another sticky component Baidu has going for it.  I’m building to something here.

Outside of social media some of Baidu’s newest launches have caught fire.  In a country where entirely cities are built in a year, maps are naturally pretty important.  The Chinese market leader is Autonavi Holdings (ADR: AMAP) but Baidu is poised to overtake them within two years.  From Analysys International’s data:

Do you remember MapQuest? After talking to people who actually use AutoNavi that’s what I’m convinced it is, an early mover that isn’t very good and is just asking to be replaced.  And think about why Google Maps disrupted Mapquest in the U.S.; the search side for Mapquest was through owner Yahoo.  So if you want to search for a noodle shop and how to get there, you’re going to go with the best search provider.  Once Baidu hits, say 40% market share in maps, the game is over.  Why? Stickiness.  Seeing a theme?

Everything else that Baidu is doing to make their ecosystem sticky is relatively small right now but growing.  Dropbox knockoff Net Disk is seeing some good traffic.  Baidu has introduced low-cost cellphones with its search engine as the default.  And Baidu’s new offerings in traditional ad mediums are doing alright.

But as I’ve been hinting at the real reason you want to buy Baidu is stickiness.  Despite blistering growth rates over the past decade much of China is just coming into the industrial age.  Just 39.9% of China is online compared with 77.3% of the U.S..  That still translates to 538 million people or about double the entire population of the U.S..  Baidu reaches 93% of these people and has a market cap of about $40 billion.  And no matter what regime comes to power, what provincial governor’s wife is framed and replaced with a body double at her murder trial, no matter what happens t0 the Hong Kong dim sum bond market, Baidu will continue to equal the internet in China.

This is a case where you want to be long Too Big To Fail, and because Baidu is so entrenched there is no way for any Chinese central planner shut it down (something that cannot be said for Qihoo360’s browser or Tencent’s microblog).  Instead of trying to gamewhat real estate concern will be able to bribe the most local officials or which Macau operation can get away with the most corruption, just be long the search engine that most of the Chinese are assured to use for the next decade.