October 06, 2011 at 12:17 PM EDT
Have Baidu Shares Fallen Too Far?
The stock has taken a near-term bump, but the company's prospects remain bright.

If you could take a time machine back five years and invest in one stock, you could do worse than choosing Baidu (NASDAQ:BIDU). The Chinese web-search company has been one of the most successful IPOs of the last decade and almost consistently one of the hottest tech stocks during a period when tech wasn’t so hot.

I say “almost” because of the last month. If that same time machine could let you sell Baidu shares a month ago, you might be happier today. With Chinese tech companies listing on U.S. exchanges, there have always been two concerns: first, that their accounting practices would be seen as suspect; and second, that the Chinese government would begin to change the rules in a way that hurt its tech companies.

For most of the last six years, Baidu seemed immune from both of those factors. But in the past month, they have become a problem for Baidu and other well-known Chinese tech companies trading on U.S. exchanges, such as Sina (NASDAQ:SINA), Sohu.com (NASDAQ:SOHU) and Yoku.com (NASDAQ:YOKU).

Since the end of August, Baidu is down 24%, and it’s the best-performing stock of the four. Sina is down 29%, Yoku is down 34%, and Sohu is down 36%. Only Shanda Interactive Entertainment (NASDAQ:SNDA) has held pace with the broader Nasdaq, declining a modest 5%.

There are a few reasons for the selloff. Prominent among them was a report from Reuters that the U.S. Justice Department was investigating accounting irregularities among Chinese companies that have listed on U.S. exchanges, after “dozens of China-based companies began disclosing auditor resignations or book-keeping irregularities.”

But it’s not just the U.S. government weighing down on Baidu and other Chinese Internet companies — the Chinese government appears to be doing so as well. On Aug. 30, Jeff Reeves noted that Baidu was slumping on a report in a state-run media outlet that alleged Baidu was striking deals with fraudulent advertisers (or rather, reporters fraudulently posing as fraudulent advertisers… oh, nevermind), as well as dishonest search-rank results.

Then came word this week that China’s government was tightening enforcement of rules allowing foreign ownership of Chinese companies, closing a loophole called the “variable interest entity” that allowed many Internet companies, including Baidu and Sina, to list on U.S. exchanges.

Nobody but the Chinese government seems sure why these crackdowns are coming now, but a MarketWatch writer said analysts have a few theories:

“Some see it as part of efforts to take back control over the Internet and a keep a lid on social-networking media, while others say it could be a way for authorities to lure home-grown companies to China’s domestic stock exchanges. Another theory goes that China has been embarrassed by accounting scandals of Chinese companies listed in the United States…”

horrible month of September for Baidu, the first real collapse in the stock’s six-year history. Baidu, which went public at $2.70 per ADS (or $27, before the 10-for-1 stock split last year), surged to $165.96 in late July. Since that record high, Baidu has lost a third of its value.

Some think that’s too far. While smaller, newer listings like Yoku and E-Commerce China Dangdang (NADAQ:DANG) might be affected by the DoJ investigation, larger companies like Baidu and Sina are less likely to be hurt. S&P analyst Scott Kessler said recent developments increased the risk in Baidu, so he was cutting his price target to $150 from $200. That target is still 35% above Baidu’s trading price. But as Kessler noted, “I’ve been following this company for a number of years, and I’ve gained a certain degree of comfort with their financial reporting… This is a well established company.”

Baidu’s web business is likely to thrive for some time. There are a few factors that could slow its growth – the cooling of the overheated Chinese economy, the DoJ investigation and the scrutiny and pressure of the Chinese government. If these problems pass in a few months, the 33% slide in Baidu’s shares might be a good chance to get in on future growth. The flip side is, getting in cheap on a promising stock often means taking on extra risk.


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