Have Baidu Shares Fallen Too Far?

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 wasnt 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 its 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 its 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 Chinas
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 stocks 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 thats 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 Baidus 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." Baidus 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 Baidus 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.