CASE: A-197
DATE: 02/05/09

BAIDU.COM, INC.: VALUATION AT IPO
Since its official launch in January 2000, Baidu.com, Inc. (Baidu) quickly grew to become the leading Internet search engine in China. After three rounds of private funding, Baidu registered to go public on the NASDAQ Stock Market (Ticker Symbol: BIDU) on August 5, 2005. (See
Exhibits 1 and 2 for a listing of Baidu’s private funding sources and pre-IPO share allocations.)
The initial public offering (IPO) turned out to be one of the highest-profile debuts since the
Internet bubble burst in 2000. The stock price jumped 354 percent on the first day of trading and closed at $122.54, valuing the company at about $3.96 billion based on 32.3 million shares outstanding. While the market showed strong enthusiasm for the stock, Baidu’s public offering nevertheless generated much debate in the investment community about the underlying value of the firm.
Furthermore, concerns were raised about whether or not Baidu was able to sustain its growth rate and exceed investor expectations after the IPO. Factors leading to this uncertainty included: the state of the Internet-paid search market in China, the expected growth in the marketplace, the competitive landscape, and the strength of Baidu’s business model and strategic position.
BACKGROUND ON CHINA’S ADVERTISING AND ONLINE ADVERTISING MARKETS
Advertising Market
From 1995 to 2005 China’s advertising market grew at a compounded annual growth rate
(CAGR) of 17 percent, which was substantially higher than China’s nominal annual GDP growth rate of 11 percent over the same period. China’s strong economic growth had resulted in increased demand for products and services, both in business and consumer product categories.
In 2005, the total advertising spend in China was approximately $10 billion, equivalent to 6 percent of the U.S. market. Though still a small market compared to the U.S., China’s

Jennie Tung and Sara Gaviser Leslie prepared this case under the supervision of Professors Joseph Piotroski and
George Foster of Stanford University, Ning Jia of Tsinghua University, and Martin Haemmig of CeTIM as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 2009 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: cwo@gsb.stanford.edu or write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University,
Stanford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means –– electronic, mechanical, photocopying, recording, or otherwise –– without the permission of the Stanford Graduate School of Business.
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advertising market was estimated to reach $12 billion in 2006 and $17 billion in 2008.1 (See
Exhibit 3 for size of China’s advertising market.) During the period of 2001 to 2005, the total amount spent on traditional media, such as television, radio and magazines, remained relatively flat as a percentage of total advertising spend, while newspaper advertising lost share and was expected to continue to decline. In contrast, online advertising was the fastest-growing segment in the advertising market, contributing to less than 1 percent of total advertising spend in 2001, but reaching an estimated 5 percent in 2005.2
Online Advertising Market
By 2005, China’s online advertising market was still in a nascent stage, but poised for rapid growth in the next 10 to 15 years. China’s online advertising market was estimated at $423 million in 2005—a 48 percent increase from 2004, but still only 3.4 percent of the U.S.’s online advertising market in the same year.3 Growth of the online advertising market was driven by several factors: an increasing number of Internet users, a growing advertising spend, and generally favorable macroeconomic trends in China as the population became increasingly wealthy. (See Exhibit 4 for size of China’s online advertising market.)
Internet Users
According to Internet research firm iResearch, the number of Internet users in China was projected to grow from 115 million in 2005, to 187 million in 2007, a CAGR of 27.5 percent.4
The long-run Internet user growth was projected to be 8 percent CAGR between 2005 and 2015.
In terms of user profiles, China’s Internet users were generally young (81.3 percent were under
35) and educated (greater than 54.5 percent had a tertiary education). 5 (See Exhibit 5 for
China’s Internet user profiles.) These demographic profiles resulted in a very attractive consumer group that also tended to have significant spending power.
Combined with the advantages of this attractive consumer group was the increasing popularity of online search in China. By 2005, online search had gained significant traction among Chinese
Internet users. According to Internet research firm comScore, only 64 percent of Chinese
Internet users used online search engines in 2002; by 2005 that number had jumped to 87 percent, which was roughly in line with the trend in the U.S.
Internet Paid Search Market Overview
Market Size
China’s Internet-paid search market, a sub-segment of online advertising, was estimated at $127 million in 2005, representing an 84 percent growth rate from 2004. This market, however, was equivalent to only 1.8 percent the size of the U.S. paid search market in 2005. In addition, the
1

Lilian Zhou et al., “Baidu.com, Enter the Dragon,” Bear Stearns Equity Research – Consumer Internet, January
29, 2007, pp. 62-63.
2
Ibid.
3
Wallace Cheung et al., “Baidu, in Search of Excellence,” Credit Suisse First Boston Equity Research – Consumer
Internet, September 22, 2005, pp. 8-9.
4
Baidu.com Inc., “Form F-1,” August 03, 2005, pp.1-3.
5
China Internet Network Information Center, “Statistical Survey Report on the Internet Development in China,”
CNNIC, July 2006 (originally quoted in Wallace Cheung et al.).

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paid search market in China only accounted for 25 percent of total online advertising spend in
2005, while that number was 43 percent for the U.S. in the same year. The paid search market in
China was projected to grow at a CAGR of 28 percent from 2005 to 2015. 6 (See Exhibit 4 for size of paid search market vis-à-vis total online advertising market, and Exhibit 6 for comparison of China vis-à-vis U.S. online advertising market.)
Internet-Paid Search Revenue Model
Internet-paid search allowed businesses that wanted to advertise online to pay for the placement of Web links in keyword search results. When an Internet user entered keywords in the search engine search box, the search engine returned a list of potentially relevant Web links. Businesses that wanted to appear at the top of the list could pay search engines to place their Web links in premium positions, with the hope that users would then click through to their Website.
Internet search engines, such as Google and Baidu, generated revenue by charging advertisers a fee for placement of Web links in keyword search results. There were two types of revenue models: a flat, or fixed-fee model, and a pay-for-performance (P4P) model. A P4P fee was based on price per click (PPC), click-through rates (CTR), and search traffic. The pricing formula was given by P4P fee = PPC x CTR x search traffic.
In the P4P model, the ranking of an advertiser’s web link was determined by its PPC, which was either a fixed price or a price determined through an auction system. During auction bidding, advertisers competed for a search-results ranking through keyword price bidding. In China, by
2005, the paid search revenue model for most search engines had migrated to the auction-based
P4P revenue model, as this model gave advertisers and search engines greater transparency on return on advertising spend (ROAS). Baidu’s business was primarily based on the auction bidding P4P advertising model.
Characteristics of China’s Paid Search Market
As a developing online advertising market, China’s Internet-paid search market had two distinctive characteristics: small and medium-sized enterprises (SMEs) as the key advertiser base, and the use of distributors as middlemen.
Figure 1: China’s Paid Search Market Structure

Advertisers
(Customers
of Search
Engines)

Distributors
(National,
Regional, and
Local)

Search
Engines

Internet
Users

Only large enterprises or multinational corporations generally dealt directly with search engines

Source: Compiled by authors using CSFB Research Report, "Baidu, in Search of Excellence," September 22, 2005.
6

Cheung, op. cit., pp. 10-13.

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SMEs as Key Advertiser/Customer Base
China’s SMEs were a key customer group for search engines. With limited advertising budgets,
SMEs were able to use search advertising as a way to maximize their market exposure. Before paid search services existed, SMEs advertised in traditional media, such as telephone directories or newspapers. However, traditional media did not always reach the targeted customer groups.
In contrast, paid search services enabled SMEs to obtain a better return on advertising spend by connecting them to their targeted customer groups. According to iResearch, approximately
410,000 SMEs in China used paid search advertising services in 2004, equivalent to a 1.8 percent penetration of the SME market. The SME penetration rate of paid search was projected to reach
2.7 percent in 2005. (See Exhibit 7 for paid search usage and average annual spend per customer.) Paid Search Primarily for Advertising
As of 2005, China’s Internet paid search market was primarily for advertising and was not related to e-commerce. Despite a growing Internet user base, the slow development of banking and credit card systems in China hindered the growth of China’s e-commerce market. As such, most advertisers invested in paid search to drive users to access their corporate information.
Internet users would then contact the advertiser by phone rather than e-mail or e-commerce. As e-commerce became more widely adopted in China, advertising links on search engines were projected to provide more concrete e-commerce revenue to advertisers.
Distributors as Middlemen
A unique aspect of China’s paid search market was the use of distributors to sell advertising.
Distributors were critical in educating Chinese businesses, in particular SMEs, about the efficacy of paid search advertising. According to iResearch, there were 20 million SMEs in China as of
2005. In top-tier cities, only 50 percent of SMEs had websites, and this number was much lower in developing cities. Given the large number of SMEs and the dispersion of these businesses across China, search engines had to rely on local distributors to serve potential customers. There were several types of distributors in China: national distributors, covering the entire country; regional distributors, covering a province or a collection of nearby cities and towns; and local distributors, covering a single city or small towns.
In general, distributors performed several roles in the online advertising market in China:
•
•

•
•

Brand building—distributors often employed a sales force that would either call or visit
SMEs in the local area to build brand awareness of the search engine.
Customer education—distributors had to educate customers about the benefits of using search engines, including online advertising concepts, such as lower cost per thousand impressions (CPM), high transparency of website traffic, and improved revenue after paid search services.
Sales and marketing—distributors provided advisory services and proposals to potential customers. The proposals often included a portfolio of keywords for the specific business and the bidding strategy for each keyword.
Payment channel—distributors acted as payment collection agents for search engines. In general, search engines required customers to maintain a minimum deposit in order to participate in bidding.

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•
•

p. 5

Ongoing customer services—distributors provided all aspects of customer service, including website development and the hosting of websites.
Risk reduction—in some cases, distributors filtered censored content, for example, politically sensitive keywords. Distributors also played a role in ensuring that the SMEs were not selling illegal products and services.

BAIDU STRATEGY AND BUSINESS MODEL
According to research firm Alexa.com, Baidu was the top search engine in China by traffic, the largest portal in China, and ranked fifth globally in 2005. As the top search engine, Baidu provided one of the largest Chinese-language search indices with over 740 million web pages, 80 million images, and 10 million multimedia files.7 In addition to being a leading search engine,
Baidu was the first China domestic portal to provide P4P advertising services in China.
Strategy Overview
Since its inception, Baidu had developed strategies to compete with foreign players, such as
Google and Yahoo!, and to differentiate itself from local competitors, such as Sina and Sohu. In addition to investing heavily in research and development (R&D)—in comparison to other local
Chinese technology companies—Baidu also leveraged its local market knowledge to develop
China-specific products and a China-relevant distribution channel. At a high level, Baidu’s strategic plan focused on two main areas: (1) development of global standard technology with
China-relevant products in order to differentiate Baidu from both foreign and local competitors and (2) full penetration of the SME segment, with a flexible multi-tier distribution system.
Baidu Products
Baidu’s founders, Robin Yanhong Li and Eric Yong Xu, were Chinese nationals who had completed at least a portion of their higher education in China. As such, they had an in-depth understanding of the local market. Leveraging their local knowledge, Baidu developed a series of products that were specific to the China market. This was in contrast to the approach of some of the global search players that offered global products modified to fit the Chinese audience. In
2005, Baidu’s products could be classified into three categories:
•
•
•

7

Search—websites, directories, images, and MP3 music files. New products in the pipeline included movies, local content, products for personal digital assistants (PDAs) and wireless access protocols (WAPs).
Community—Baidu community and WAP Post Bar. New products in the pipeline included Baidu Knows and Post Bar.
Enhancements—Sobar (a tool that, once installed, showed up on a computer's tool bar and made search functionality readily available on every web page that a user browsed), and search ranking. New products included dictionaries and desktop searches.

Baidu.com, Inc., loc. cit.

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In addition to query-related searches that provided users with a list of relevant websites (P4P advertising model), Baidu had been able to drive traffic to its site by the use of several non-query search products. Examples of these products follow.
MP3 Search
Music was a key application in China’s Internet space. In November 2002, Baidu was the first search engine in China to launch MP3 search services. This move effectively differentiated
Baidu’s products from traditional search engines, particularly Google. This capability also created a distinctive brand image and recognition of Baidu among China Internet users as the domestic search engine, providing more suitable and locally relevant services for the Chinese audience. Baidu’s search traffic grew fourfold within one year of launching the MP3 search.8
Post Bar
Launched in 2004, Post Bar was similar to a query-based community or chat room service for knowledge sharing. After searching for a keyword, users could create a new chat room based on the search word, or participate in the keyword bar based on that keyword. With over 1 million bars created by users, Baidu was the first and only search engine in China to provide communitybased search services in 2005. Post Bar increased the stickiness of Baidu’s usage and traffic by enabling users to chat with other online participants and learn about other keyword-related subjects. In addition, Internet users were required to register before joining Post Bar, allowing
Baidu to better identify its user base and online communities.9
ProTheme
In February 2005, Baidu launched ProTheme, a contextual advertising service (this product was similar to Google’s AdSense). Baidu had developed the technology to better understand Baidu
Union 10 members’ web page content and extract relevant keywords. The ProTheme system then matched these webpage keywords with advertisers’ bidding keywords, and displayed relevant adverting links on Baidu Union members’ pages. Consequently, this service increased clickthrough rates (CTR) without incremental search traffic. Baidu shared revenue with union members once these advertising links were clicked through.11 In 2005, 40 of Baidu’s 76,000 union members participated in the ProTheme service. As this was a new service, revenue was still insignificant in 2005, but was expected to display growth over the next several years.
Baidu Revenue Model
P4P
Baidu’s P4P advertising service was Baidu’s core product, generating 75 percent of the firm’s total revenue in 2005.12 Baidu was the first Chinese search engine to provide auction-based P4P advertising services in China. Advertisers or Baidu customers were allowed to choose an unlimited number of keywords and localize their advertising links, depending on the search traffic. Advertisers could then select a maximum bidding price on each keyword and the system automatically outbid the competing advertisers until the maximum price was reached.
8

Cheung, op. cit. pp. 19-21.
Ibid.
10
Baidu Union was Baidu’s network of third-party websites and software applications.
11
Ibid.
12
Ibid.
9

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Advertisers were able to monitor the list of bidding prices and select the appropriate bidding price. P4P revenue for Baidu was based on: price per click (PPC), click-through rates (CTR), and search traffic. The formula for calculation was P4P fee = PPC x CTR x search traffic.
In terms of P4P pricing, Baidu’s minimum bid or PPC was RMB 0.3013 and RMB 0.10 per incremental bid—the highest rate among all search engines in China in 2005. Advertisers had to pay deposits to Baidu for registration in the amount of RMB 2,400—again, the highest for all search engines in China.14 (See Exhibit 8 for pricing scheme for major players in the Chinese market.) Branded Advertising
Baidu also offered fixed payment advertising links and banner advertising on non-query search products. Fixed payment advertising links guaranteed that the advertiser’s website would appear in a fixed location (rank) of a given keyword’s search results. Advertisers usually paid Baidu a pre-negotiated amount for this service. The key customers of banner advertising services were generally large corporations, not SMEs. For example, if a user searched for popular Chinese singer Jay Chou in Baidu MP3, the search result page would also deliver a banner advertisement for cell phones and MP3 players. In this case, the advertisers of cell phone and MP3 players would have paid Baidu a fee for serving up their advertisements along with the search results.
Baidu’s revenue from branded advertising had historically been less than for P4P; however, branded advertising revenue tended to increase with Internet traffic.
Baidu Sales and Distribution Model
Baidu pioneered a multi-tier sales and distribution model, which provided the company with a substantial competitive edge in China’s developing paid search market. Baidu understood that, given the relatively low levels of technology readiness amongst SMEs in China, a high-touch sales and distribution model was necessary to educate and sell to these potential customers.
Baidu’s distribution network was divided into three parts: regional distributors/sub-distributors, direct sales team, and large account management team.
Regional Distributors/Sub-distributors
In most cities, Baidu appointed an exclusive distributor to operate in either that city or region.
The distributor was prohibited from selling competitors’ products. In larger cities, such as
Beijing and Guangzhou, Baidu had two distributors. As of 2005, Baidu had 60 exclusive distributors and approximately 300 sub-distributors, serving over 80 percent of its 50,000-plus customers and the 20 million-plus potential SME customers in China. In 2005, distributors contributed around 60-70 percent of Baidu’s P4P revenue. 15 (See Exhibit 9 for a brief description of requirements for Baidu’s distributors.)

13

$1 = RMB 8.11 in July 2005.
Cheung, op. cit., pp. 22-24.
15
Cheung, op. cit., pp. 25-27.
14

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Direct Sales Team
Baidu’s direct sales team targeted mostly larger-scale customers, who generally needed more professional and sophisticated services. Some of these clients included regional conglomerates or large local companies.
Large Account Management Team
Baidu set up large account management teams to provide tailor-made advertising products to target multinational companies (MNC) and large state-owned enterprises. For example, tailormade solutions included P4P keyword advertising and banner advertising on MP3 search. In
2005, notable MNC customers of Baidu included Motorola, Sony, Intel, and China Mobile.
Multi-Tiered Distribution Model
Baidu’s multi-tiered distribution model provided several advantages over the traditional national distributor model, which some of Baidu’s competitors were using. Distributors in different geographies provided segment-specific services that were most relevant for a specific geography.
While national distributors tended to focus mainly on developed areas, local and regional distributors helped achieve good penetration in developing regions by using their local knowledge and contacts. Finally, many of Baidu’s distributors started out small, with 10 to 20 staff. Therefore, these distributors relied on Baidu’s business for their own growth and profitability. Given this dynamic, Baidu only shared 33 percent of its revenue with these distributors; in contrast, Baidu’s competitors shared 50 percent of their revenue with national distributors. Baidu believed that, in the long term, it would be important not to rely too heavily on distributors. In 2005, Baidu announced plans to increase its direct sales force in the future, in order to provide better and more sophisticated services to customers.
Baidu Advertising Customer Profile
In the second quarter of 2005, Baidu had 41,248 active online advertising customers, with average revenue per user (ARPU) of RMB 591. In terms of industry group breakdown, Baidu’s top 37 industry customer groups accounted for 70 percent of all P4P revenue in January 2005.
No single industry group contributed to more than 10 percent of P4P revenue. The top industry groups included health care, manufacturing, IT services, entertainment, ticketing and games, dating services, and household services.
In terms of user profile, Baidu users tended to be younger and have lower income than Google’s user base. In China’s high-end user group, Baidu’s market share was lower than that of Google.
COMPETITION
In 2005, 10 players crowded the search engine market in China. The market dynamic was similar to that of the U.S. in 2000. In terms of market share, in 2004, Google had a 22 percent share of China’s search traffic and Alibaba/Yahoo!16 held a 30 percent share. However, these

16

Post merger of Alibaba, Yahoo! China, and 3721.com.

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global players were still behind Baidu, which held a 33 percent share of China’s search traffic.17
The remaining players each held less than 10 percent of the traffic. (See Exhibit 10 for share of
Internet traffic by players.)
International Competitor: Google
In 2001, Google launched its tailored search services with simplified Chinese characters.
However, Google had not co-operated with the Chinese government to filter inappropriate content. As a result, in 2005, Google had still not been granted a license to operate in China; all its servers were hosted outside of China. Without a localized operation and R&D team,
Google’s business exposure in the China market was low. This allowed Baidu to expand. (See
Exhibit 11 on search engine product market share comparison among Google, Baidu and others.) Recognizing its importance, Google took an aggressive stance toward the China market at the beginning of 2005. In May 2005, the Chinese government approved Google’s application to establish a R&D office and mainland office in China. Google appointed Dr. Kai-Fu Lee, the former corporate vice-president of Microsoft’s Interactive Services Division to head Google’s
China R&D efforts. To meet the unique distribution landscape of China’s Internet advertising market, Google started to develop a distributor system in China and had appointed four regional distributors to cover key areas in China. Finally, Google started to develop localized search products. For example, Google’s University Search feature helped prospective students search for information about major Chinese universities.
As Google expanded into China, it needed to address a number of challenges in order to become a market leader there. For example, many local Chinese SMEs were not familiar with Google and many of them were not able to pronounce “Google.” In search result relevance, some websites that appeared in Google search results could not be accessed because Google had not filtered out inappropriate content websites, according to the Chinese government’s definition.
Finally, from a technology perspective, Baidu had been focusing on the Chinese language, which is represented by the double-byte system; in contrast, Google’s strength was in the single-byte universe, which was how the English language is represented. (See Exhibit 12 for Baidu and
Google business model comparison, and Exhibit 13 for Baidu and Google revenue growth rate comparison.) International Competitor: Alibaba/Yahoo!
Yahoo! had been trying to establish its presence in China since 2000, but the response had not been positive. In December 2003, Yahoo! acquired a Chinese local quasi-search service provider 3721.com for $100 million. After its integration with 3721.com, Yahoo! launched an independent and localized search engine called Yisou. Yisou provided China-specific search services, including MP3 and images. A unique feature of Yisou was its real-name service, which allowed Internet users to access websites by typing the name of the website in Chinese characters into the search field without memorizing the actual English-language domain name.

17

Cheung, op. cit., pp. 41-43.

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After one and a half years of operations, Yahoo! was ranked among the top three in e-mail and paid search services in China. It still lagged behind the leaders in the instant messaging and portal segments. Despite having brand recognition, capital, and technology backup, global players such as Yahoo! faced intense competition from listed Chinese Internet companies and domestic entrepreneurs. Local players had superior local knowledge, strong execution capabilities, and sufficient capital resources from venture funding.18
To improve its competitive positioning, Yahoo! chose to work with a local partner that had strong execution capabilities, an understanding of China’s unique culture, and the ability to work with a U.S. company. In August 2005, Yahoo! paid $1 billion to acquire a 40 percent stake and
35 percent voting rights in Alibaba.com, a successful China-based online trading company.
Alibaba brought to the table a number of assets including a strong brand, a high-end user base from its consumer-to-consumer (C2C) portal, a well-developed successful direct sales force, a large advertiser base, and superior execution capabilities.
Like Baidu’s other global competitors, the Alibaba/Yahoo! partnership also faced a number of challenges in China. For example, Alibaba had never completed a merger prior to this one, and the possible integration challenges were many. In addition, Alibaba had not been a technologyfocused company and did not have a large R&D team. Given that the search business required heavy investments in R&D, Alibaba/Yahoo! would need to invest significantly to build the same capabilities as Baidu.
Local Competitors: Sina and Sohu
Domestic portals Sina and Sohu were the dominant players in China’s Internet search market before the emergence of independent search engines, such as Baidu and Google. However, after the bursting of the Internet bubble in 2000, these domestic players scaled back their operations to focus on portal development and spent less on the loss-generating (but fast-growing) paid search market. From 2002, these domestic portals recognized the potential of SME advertising in China and decided to develop strategies to extract value from SMEs. Unfortunately, their effort to launch business portals did not attract significant traffic and contributed to less than 10 percent of their advertising revenue. These firms also tried licensing search technologies from independent search companies, such as Baidu and Google, but users preferred to query the search engines directly. As a result, Sina and Sohu ultimately decided to terminate their licensing agreements with the search engine companies. While both of these companies had historically been leaders in online advertising (through their portals and directory products), they had lost ground to Baidu in the paid search market.
Given the growth of the paid search advertising market, Sina and Sohu decided to develop inhouse search technology to regain traffic from Baidu and Google. They followed Baidu’s distribution strategy and used regional and local distributors instead of national distributors.
Both of these companies launched their services in 2005 and generated revenue from fixed
18

Cheung, op. cit., pp. 33-34.

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payment and P4P revenue models. (See Exhibit 14 for revenue share of key players in the paid search market.)
BAIDU STRATEGIC POSITION
Strengths
As the leading search engine in China in 2005, Baidu had several competitive advantages over both its local and global competitors. Notable strengths included Baidu’s unique search technology, focused China strategy, large user base, and well-developed distributor network.
Leader in Chinese-language Search
Given the complexity of the character-based Chinese language, Baidu invested heavily to develop its proprietary search technology. Co-operating with various universities and scholars,
Baidu developed Chinese language processing search techniques, including spider systems, indexer systems, and search systems. These techniques took into account word segmentation, parts of speech, grammar, and encoding that enabled Baidu to achieve improved search relevancy and efficiency. Given Baidu’s local knowledge and understanding of Chinese consumer behavior and advertiser needs, the company was able to tailor its search products to the local market and effectively differentiate itself from the global competitors. The company’s significant investments in R&D also led to innovative search products, which allowed the firm to differentiate itself from other local players.
Focused China Strategy
Unlike its global competitors, Baidu had a China-focused strategy from the very beginning. The company’s R&D, sales and marketing teams consisted mostly of local talent and were based entirely in China. As such, Baidu was able to deliver products and services, such as MP3 search, that were targeted specifically to the Chinese Internet users. Additionally, given that China was the only market the company was targeting as of 2005, the Chinese market had management’s full attention and controlled the firm’s resource allocation.
Large User Base
As an early entrant into China’s Internet search market, Baidu enjoyed certain advantages by establishing its brand name early amongst Internet users. Apart from providing search-related services, Baidu also promoted online community-based products such as Post Bar in an effort to retain its users and build stronger customer loyalty. In addition, because Baidu’s founders were
Chinese nationals and its operations were based entirely in China, the company was recognized for being a national brand, despite the fact that it was incorporated in the Cayman Islands and its private investors were mostly foreign. Being the most widely recognized Chinese Internet search brand won Baidu significant market share from supporters of international brands, such as
Google. All of these enabled Baidu to create a large volume of search traffic and a large Chinese
Internet user base, which in turn attracted more advertising customers and generated more paid online advertising businesses.

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Well-Developed Distributor Network
Baidu had developed close relationships with its distributor network, by providing information and analysis to enable distributors to win more business. In 2005, Baidu had the largest distributor network for online paid search products in China.
Weakness/Risks
Despite its leadership position in China’s search market in 2005, Baidu needed to continually address several challenges.
Skepticism of Revenue Model
In Baidu’s P4P revenue model, the ranking of an advertiser’s web link was determined by its price per click (PPC) through an auction system. Though innovative, the fact that this revenue model gave priority to advertising rather than relevant search results had also raised skepticism about quality and possible bias in Baidu’s search results. In comparison, Google and
Alibaba/Yahoo! more clearly separated advertisements from relevant search results by placing them on the right side of the page. In addition, Baidu’s P4P clients were not subject to fixedterm contracts, therefore they could terminate their business with Baidu and switch to other
Internet search engines at any time if Baidu failed to provide them with competitive pricing and quality services.
Competition
Competition from global and local players was intensifying. Global players such as Google and
Alibaba/Yahoo! had much deeper pockets to invest in the market. Baidu’s business could be severely impacted if the company failed to continue to drive high traffic.
Baidu Union Members
Baidu Union members were a critical factor in driving traffic to Baidu’s site. They placed Baidu search boxes on their websites and earned P4P revenue from Baidu when Baidu Union member users searched keywords through the search box and clicked through relevant results. However, these union members could terminate their contracts with Baidu at any time. For example, this already occurred when leading domestic Internet portals, Sina and Sohu, terminated their business with Baidu. Even if union members decided to stay with Baidu in the future, they could demand increases in fees, which would impact Baidu’s traffic acquisition costs.
Management
Baidu’s senior management’s options were due to be fully vested by 2007. This had the potential to cause significant management instability for the company.
Click Fraud
Click fraud occurred when a search engine artificially generated clicks to boost its advertising revenue, or when an advertiser’s competitor artificially generated clicks to boost an advertiser’s costs. It could also occur when page reloads on an advertiser’s site were counted as multiple clicks, or when accidental clicks on an advertisement by Internet users were included in the results fed back to the advertiser. Click fraud greatly impacted the quality of search results and was potentially costly to advertisers. This was an area that Baidu had to combat to justify the integrity of its search results and quality of service to advertisers.

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Enforcement of Intellectual Property Rights
MP3 search was one of Baidu’s pillar services and helped the company generate loyal client communities. However, this service had also raised concerns from record companies over intellectual property and copyright-related issues. Baidu had to address these issues and find ways to avoid copyright problems and potential lawsuits.
Sustaining Growth
Just like any other emerging companies, Baidu also faced the pressure of sustaining its growth rate and maintaining its dominant presence in the Internet-paid search market after an initial period of rapid growth. However, it was necessary to balance growth and expansion with a cautious approach to the risks involved.
China Risks
In addition to the typical business risks associated with a new company, Baidu was also subject to a number of country-specific risks. These included:
•
•

•

•

•

•

Economic growth—any economic slowdown could lead to reduced advertising spending from its customers.
Chinese government censorship—restrictions on certain Internet content could interfere with the quality of search results, thus impacting user adoption and retention. For example, the government could mandate search engines to filter search keywords that were deemed improper, or demand the removal of unsavory content.
Government regulation of Internet cafes—government had intensified its regulation of
Internet cafes in China, especially with respect to the closure of unlicensed Internet cafes.
As a large number of users in China accessed the Internet from Internet cafes, these actions could adversely impact user traffic.
Click fraud—while click fraud existed on all online search services, the problem in China was particularly serious. This was due to the complex distribution arrangement where the middleman added an extra layer of complexity. Additionally, China’s legal system had yet to develop the regulations and enforcement to minimize click fraud.
Enforcement of intellectual property rights—Baidu, like all search engines, had invested significantly in developing proprietary search algorithms. It was not clear if China’s evolving intellectual property laws would be sufficient to protect Baidu’s trademarks and trade secrets.
Taxation laws—China had been providing tax incentives to technology companies but these schemes were subject to government revision at any time.

DECISION TO GO PUBLIC ON THE NASDAQ
To sustain Baidu’s growth, the management team laid out several key themes in 2005: sustain high growth of search traffic and unique visitors, strengthen the three-tier distribution network in order to monetize search traffic, expand the Baidu Union network, continue to invest in R&D to develop Chinese-based search products and technology for growth and differentiation, and explore merger and acquisition (M&A) opportunities for earnings accretion and traffic growth.

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These efforts required increased levels of capital investment. Baidu’s management team decided the best way to raise the funds was to go public. Since Baidu was technically a wholly foreignowned company (registered in the Cayman Islands), the company was ineligible for listing on either the Shanghai or Shenzhen exchanges. As such, the key listing alternatives for Baidu were the NASDAQ Stock Market, the Hong Kong Stock Exchange, or the London Stock Exchange.
The company believed that listing Baidu on NASDAQ would offer them a technology-related valuation premium. Though a NASDAQ listing resulted in higher compliance costs, greater potential litigation costs, and adherence to requirements of the Sarbanes-Oxley Act, technology companies that listed on NASDAQ often received better valuations in terms of traditional valuation metrics (e.g., price to earnings ratios). Additionally, compared to Hong Kong or
London, there were more securities analysts covering NASDAQ-listed companies. And, relative to the investor bases in London and Hong Kong, buyers of NASDAQ-listed stocks were more likely to take risks on a company with a short track-record of profitability. In fact, Hong Kong had very stringent requirements for companies listing on its exchange; most prominently, companies had to show a three-year profit record to be eligible for listing. Trying to capitalize on Google’s and Yahoo!’s successes, Baidu determined that NASDAQ’s strong technology association, combined with the resultant prestige associated with a NASDAQ listing, made a
NASDAQ listing the most sensible choice for the company.
VALUATION

AT IPO

Baidu filed for an IPO on the NASDAQ Stock Market on August 5, 2005. Given that Baidu’s business model was a relatively new one in China and the company was operating in an emerging market and economy, there was much debate in the investment community about the appropriate valuation of Baidu. The following sections provide the background on various factors that impacted the valuation of Baidu at the time of its IPO.
Revenue Analysis
Baidu had four key revenue sources (see Exhibit 15 for revenue trend), which included the following: P4P advertising—auction-based pay-for-performance keyword search services
Online/banner advertising—tailored solution mainly for large advertisers/customers
Enterprise search—search software and services provided to company websites
Portal search—search services to portals (but services could be terminated after 2005)
P4P Revenue
As discussed above, P4P revenue was driven by the price per click (PPC), click-through rates
(CTR), and search traffic: P4P fee = PPC x CTR x search traffic
Historically, search traffic grew as the number of Internet users increased. Through its local distribution network, Baidu had continued to steadily add new SME customers, while customers were bidding for a wide range of keywords, thus generating higher CTR. Additionally, more

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customers were competing for the same keywords, driving the PPC higher. Together, these factors translated into increases in both customer numbers and average revenue per user (ARPU).
Online Advertising
Online advertising revenue was generated mainly from non-query-based searches, for example, searches on MP3 and image files. In general, these types of searches grew in tandem with the total amount of Internet traffic.
Enterprise Search and Portal Search
According to Baidu, revenue for enterprise search was expected to grow at a much lower rate than that of online advertising revenue. Portal search revenue would likely decline as the company exited that business.
Cost Analysis
Costs of Sale/Services
A key part of the firm’s costs of sales/services were driven by traffic acquisition costs (TAC), which were defined as the amount Baidu paid to generate traffic on its site. Given that Baidu had a revenue-sharing agreement with Baidu Union members, the revenue-sharing portion was recognized as a traffic acquisition cost. Total costs of sales were also influenced by bandwidth costs and depreciation expenses. (See Exhibit 16 for costs of sale/services trend.)
Operating Costs
Baidu’s operating costs consisted primarily of: sales and marketing costs, general and administration costs, research and development, and share-based compensation. In terms of labor costs, Baidu increased its staff from 328 in 2004 to over 1,000 in 2005, in addition to 200 employees the firm inherited as part of the Qilang acquisition (a key distributor).19 The majority of additional staff was in the direct sales team and the R&D department.
Share-based compensation (SBC) was granted to certain employees based on performance of company. This non-cash expense accounted for 14 percent of Baidu’s total gross revenue in
2004 and was estimated to account for 11 percent in 2005. SBC expense was determined based on three main factors: the number of options to be issued, the prevailing closing price, and the exercise price of recently issued options. These factors, in turn, depended on management discretion and market conditions which made forecasting SBC sometimes a challenging task.
(See Exhibit 17 for operating costs trend.)
Capital Expenditures
Baidu needed to continually invest in server technology to maintain server capacity and shorten response time for user requests. Baidu’s capital expenditures (CAPEX) in 2005 were $10 million for the China market. As a reference, Google spent $750 million in CAPEX for the global market. (See Exhibit 18 for CAPEX trend.)
Baidu’s historical financial information is provided in the Income Statement (see Exhibit 19), the Balance Sheet (see Exhibit 20), and the Cash Flow Statement (see Exhibit 21).
19

Cheung, op. cit., pp. 41-49.

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Taxation
In 2005, according to China’s Income Tax Law, foreign invested enterprises (FIEs) established in China were generally subject to an enterprise income tax rate of 33 percent. However, FIEs that qualified as a “new or high technology enterprise,” such as Baidu, were entitled to a preferential enterprise income tax rate of 15 percent. Additionally, Baidu was entitled to a threeyear exemption starting from its first year of operation (expired on December 31, 2002) and was entitled to a preferential enterprise income tax rate of 7.5 percent for the succeeding three years
(expired on December 31, 2005). After December 31, 2005, Baidu would need to pay the preferential tax rate of 15 percent, so long as it continued to be registered in a high-tech zone and maintained its “new or high-technology enterprise status.” Baidu’s status was subject to annual review by the Chinese government.20
Valuation Analysis
Three alternative approaches can be used to value Baidu at the time of its IPO, the discounted cash flow (DCF) model, the economic profit (EVA) model, and the comparable multiple valuation model, respectively. A key set of valuation inputs are forecasts of the company’s future financial performance based on its value drivers. Exhibits 22, 23 and 24 present one particular set of Baidu’s pro-forma financial statements (income statements, balance sheets, and cash flow statements, respectively) over the period 2005 to 2010. Exhibit 25 provides other valuation relevant information such as the weighted average cost of capital (WACC), and valuation multiples of several comparable domestic and international companies.
STUDY QUESTIONS
1. What are the key determinants of value, or value drivers, for Baidu?
2. Given the decision to pursue an initial public offering, on what exchange should Baidu list?
What factors contribute to that decision? What are the advantages and disadvantages of listing on the NASDAQ?
3. What are the strengths, weakness and/or limitations associated with implementing the discounted cash flow (DCF) valuation model, the economic profit (EVA) valuation model, and the comparable multiple valuation model, respectively?
4. What are the key business risks and challenges for Baidu going forward?

20

Baidu.com Inc, op. cit., pp. 56-58.

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Exhibit 1
Baidu Private Funding Sources
February 2000: Series A Convertible Preferred Shares
Integrity Partners, LLC
Peninsula Capital Fund, LLC
September 2000: Series B Convertible Preferred Shares
Draper Fisher Jurveston ePlanet Ventures
IDG Technology Venture Investment, LP
Integrity Partners, LLC
Peninsula Capital Fund, LLC
June 2004: Series C Convertible Preferred Shares
Draper Fisher Jurveston ePlanet Ventures
Integrity Partners, LLC
Peninsula Capital Fund LLC
CMT CV-BD Limited
Venture TDF Technology Fund III
China Equity International Holding Company Limited (BVI)
Swiftcurrent Offshore, Ltd.
Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

Exhibit 2
Baidu Pre-IPO Share Allocations
Number of Shares (in millions)
Shareholding Structure
Directors
Robin Li
Jerry Liu
Shawn Wang
David Zhu
Dong Liang
Eric Xu
Integrity Partners
Peninsula Capital
Draper Fisher
IDG
Google
CMT
Venture TDF
China Equity
Swiftcurrent
Others
Public Float
Total

Class A

Class B

0.04

Pre-IPO
Preferred Shares Total Shares

7.44
0.28
0.17
2.38

0.24

0.26

1.66

0.30

12.17

3.2
2.95
7.95
1.44
0.75
0.16
0.15
0.02
0.01

16.65

Total Options

7.44
0.32
0
0.17
0
2.38
3.2
2.95
8.19
1.44
0.75
0.16
0.15
0.02
0.01
1.92

0.08
0.05
0.32
0.14
0.12

29.10

2.06

1.35

Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

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Exhibit 3
China's Advertising Market
(in US$ billions)
Advertising spend (all media)
CAGR (03-08E)

2003
7.6

2004
9.0

2005
10.6

2006E
12.0

2007E
14.3

2008E
17.0
18%

Source: ZenithOptimedia; iResearch (originally quoted in CSFB Research Report, “Baidu, in Search of Excellence,”
September 22, 2005).

Exhibit 4
China’s Online Advertising Market
(in US$ millions)
Total online advertising
Internet paid search market
% of online advertising
Brand advertising (e.g., banner)
% of online advertising

2002
74
15
20%
59
80%

2003
158
34
21%
124
79%

2004
283
69
24%
214
76%

2005
510
127
25%
383
75%

2006E
814
233
29%
581
71%

2007E
1240
398
32%
842
68%

2008E
1747
594
34%
1153
66%

2009E
2417
887
37%
1530
63%

Source: iResearch (originally quoted in CSFB Research Report, “Baidu, in Search of Excellence,” September 22,
2005).

Exhibit 5
Internet User Profiles by Age and Education Level (as of July 2005)
Age Group
Below 18
18-24
25-30
31-35
36-40
41-50
51-60
Above 60
Total

% of Users
16
39
17
10
7
7
3
1
100

Education Level
Below secondary education
Secondary education
Polytechnic
Bachelor’s degree
Master’s degree and above
Total

% of Users
14
31
26
26
3
100

Source: China Internet Network Information Center.

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Exhibit 6
China and U.S. Advertising Comparison (2005)
China
1,976
10,586
0.54
510
5
127
25

GDP (US$ billions)
Advertising market (US$ millions)
Advertising market (% of GDP)
Online advertising (US$ millions)
Online advertising (% of total advertising)
Search market (US$ millions)
Search (% of online advertising)

US
12,534
178,181
1.42
12,321
6.9
5,237
43

Source: CSFB Research Report, “Baidu., in Search of Excellence,” September 22, 2005.

Exhibit 7
SMEs in China Using Paid Search and Average Annual Spend
Number of SMEs using paid search
Estimated % of total SMEs
Average annual spend per enterprise (US$)

2001
70
0.5%
205

2002
160
0.8%
230

2003
280
1.4%
278

2004
410
1.8%
362

2005
560
2.7%
404

Source: iResearch (originally quoted in CSFB Research Report, “Baidu, in Search of Excellence,” September 22,
2005).

Exhibit 8
Pricing Scheme Comparison (2005)
(in RMB millions)
Account opening fee
Annual fee
First-time deposits
Minimum bid*
Increment bid*
* In terms of price per click (PPC)

Baidu
n.a.
600
2,400
0.3
0.1

Google
1,000
n.a.
1,000
0.15
0.05

Sohu
n.a.
600
300-1,500
0.3
0.05

Source: Company data; iResearch (originally quoted in CSFB Research Report, “Baidu, in Search of Excellence,”
September 22, 2005).

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Exhibit 9
Baidu Distribution Requirements
Item
Description
Revenue
Over 80% of revenue from Baidu P4P business
Registered capital
Over RMB 500,000
Length of terms
12-month, renewed annually
Economics sharing
-Exclusive*
Baidu/distributor - 66.7%/33.3% (RMB 50 bonus per every RMB 100 payment)
-Non-exclusive
Baidu/distributor - 71.4%/28.6% (RMB 40 bonus per every RMB 100 payment)
Exclusivity
No products directly competing against Baidu’s P4P
Scoring system for incentives
Factors including cash paid to Baidu, customer effective rate, customer quality
Incentive programs
Incentive cash bonus, marketing fund, service fee
Others
No sub-distributors unless written approval from Baidu
*Selected non-exclusive may be eligible for the exclusive sharing economics.
Source: Company data, (originally quoted in CSFB Research Report, “Baidu., in Search of Excellence,” September
22, 2005).

Exhibit 10
Internet Search Traffic Market Share Comparison
(in %)
Baidu
Alibaba/Yahoo!
Google
Sohu
Sina
Zhongsou
Other
Total

2004
33
30
22
4
2
1
8
100

2005
34
24
10
15
8
3
6
100

Source: iResearch (originally quoted in CSFB Research Report, “Baidu, in Search of Excellence,” September 22,
2005).

Exhibit 11
Search Engine Product Market Share Comparison
(in %)
Music
Image
Games
Software
Video
Website
Dictionary/thesaurus
Webpage
Corporate, product information, and news
Map, weather, traffic, travel info.

Baidu
74.6
64.8
61.0
49.7
49.4
48.3
47.2
46.8
42.5
38.8

Google
14.7
26.7
21.2
38.8
32.5
39.9
40.9
37.5
42.5
41.8

Others
10.7
8.5
17.8
11.5
18.1
11.8
11.9
15.7
15.0
19.4

Source: China Internet Information Network Center.

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Exhibit 12
Baidu vs. Google: Summary Statistics
Year of establishment
Search market share (%)
Index size (no. of Websites) (million)
2004 revenue (US$ million)
Paid search (% of total revenue)
Market
Language
Pricing model
Paid search model
Relationship with advertisers
Payment model

Baidu
Jan 2000
33
690
13
69
China
Chinese
Bidding, fixed price
Listing (right and left-hand side)
Distributor and direct sales
Prepaid

Google
Sept 1998
34
8,000
3,189
98
Global
35 Languages
Bidding only
Listing (mostly on left-hand side)
Direct online access
Post-paid

2005 Key Figures
P4P revenue (US$ million)
Search traffic (million)
Market share (%)
Click-through rate (%)
Price per click (PPC) (US$)
Net margin (%)

33
27,656
33.5
1.3
0.09
21

5,790
65,122
34
8
0.43
29

Source: CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

Exhibit 13
Baidu vs. Google: Revenue Growth Trajectory
(in %)
Baidu
Google

2003
268.2
234.7

2004
189.5
116.8

2005
176.0
92.5

2006E
171.6
71.2

2007E
95.3
38.9

Source: CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

Exhibit 14
China Paid Search Market Revenue Share
(in %)
Alibaba/Yahoo!
Baidu
Google
Sina
Sohu
Zhongsou
Others
Total

2003
38
15
5
12
22
4
4
100

2004
30
24
7
11
19
4
5
100

2005
24
34
10
8
15
3
6
100

2006E
21
39
12
6
13
3
6
100

2007E
20
42
13
6
12
2
5
100

Source: iResearch (originally quoted in CSFB Research Report, “Baidu, in Search of Excellence,” September 22,
2005).

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Exhibit 15
Baidu Revenues (2002-2005)
(in RMB millions)
Online marketing
-P4P*
-Online advertising*
Subtotal
Enterprise search
Portal search
Total revenue

2002A

2003A

2004A

2005E

1.9
2.4
4.3
1.7
5
11

26.9
4.8
31.8
2.8
6
40.6

81.2
25.7
106.9
8
2.6
117.5

216.7
60.5
277.2
10.7
1.7
289.6

2003A

2004A

2005E

66
12
78
7
15

69
22
91
7
2

75
21
96
4
1

(% of Total Revenues)
2002A
Online marketing
-P4P
17
-Online Advertising
22
Subtotal
39
Enterprise search
16
Portal search
45
*P4P and online advertising numbers in 2002-04 are estimates.

Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

Exhibit 16
Baidu Cost of Sale/Services (2002-2005)
(in RMB millions)
Traffic acquisition costs
Bandwidth costs
Depreciation of equipment
Other
Total cost of sale/services

2002A
4.2
1.1
2.6
1.6
9.5

2003A
10.6
2.2
4.1
3.7
20.7

2004A
10.9
8.5
7.1
6.5
33

2005E
16.2
26.4
24.4
13.1
80.1

Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

Exhibit 17
Baidu Operating Costs (2002-2005)
(in RMB millions)
Sales and marketing
General and administration
Research and development
Share-based compensation
Total operating cost

2002A
7.7
4.2
3.8
4.2
19.9

2003A
9.2
7.7
5.2
5.1
27.2

2004A
23.3
15.7
11.4
16.5
66.9

2005E
64.4
35
31.3
30.8
161.5

Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

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Exhibit 18
Baidu CAPEX Schedule (2002-2005)
(in RMB millions)
CAPEX spend
CAPEX (% of gross revenue)

2002A
5.7
52

2003A
8.0
20

2004A
39.4
34

2005E
81
28

Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

Exhibit 19
Baidu Reported Income Statements (2002-2005)
Year-end Dec 31 (in RMB millions)
Online marketing services
Enterprise search software
Portal search services
Total gross revenue
Less: business taxes
Net revenue
Cost of revenue
Gross profit
SG&A
R&D
Share-based compensation
Total opex
Operating profit (loss)
Interest and other income (expenses)
EBT
Tax
Net income
Net income (ex. SBC)
EBITDA (ex. SBC)

2002A
4.3
1.7
5.0
11.0
-0.5
10.5
-9.5
1.0
-11.9
-3.9
-4.2
-20.0
-19.0
0.5
-18.5
-18.5
-14.3
-15

2003A
31.8
2.8
6.0
40.6
-1.9
38.7
-20.7
18.0
-16.9
-5.2
-5.1
-27.2
-9.2
0.4
-8.8
-8.8
-3.7
1

2004A
106.9
8.0
2.6
117.5
-6.5
111.0
-33.0
78.0
-39.0
-11.4
-16.5
-66.9
11.1
1.5
12.6
0.5
12.1
28.6

2005E
277
11
2
290
-19
271
-80
191
-99
-31
-31
-162
29
6
35
-5
30
61
95

Gross margin (%)
EBITDA (ex.SBC) margin (%)
Operating margin (%)
Net margin (ex. SBC) (%)
Effective tax rate (%) (ex. SBC)
Effective tax rate (%)

5
-136
-177
-136
0
0

44
2
-23
-9
0
0

66
32
9
24
4
2

66
33
10
21
14
7

Year-on-Year Growth (%)
Gross revenue
EBITDA (ex. SBC)
Net income
Net income (ex. SBC)

n.a.
n.a.
n.a.
n.a.

268
-106
n.a.
n.a.

189
5,236
n.a.
n.a.

147
152
153
114

Basic number of ADS (mn)
Fully diluted number of ADS (mn)
EP ADS (US$) (basic)
EP ADS (US$) (FD)

n.a.
n.a.
n.a.
n.a.

10.2
12.1
-0.11
-0.09

11
31.1
0.13
0.05

27.7
34.9
0.13
0.11

Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

This document is authorized for use only in FINCE 90013 (333-632), FNCE 90023 (333-665) by Lyndon Moore from
February 2012 to August 2012.

Baidu.com, Inc.: Valuation at IPO A-197

p. 24

Exhibit 20
Baidu Reported Balance Sheet Statements (2002-2005)
Year-end Dec 31 (in RMB millions)
Cash and cash equivalents
Accounts receivables
Prepaid expenses and others
Total current assets
Fixed assets – net
Intangible assets – net & others
Total assets

2002A
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.

2003A
62.8
1.9
0.9
65.6
11.1
76.7

2004A
200.2
9.6
2.4
212.2
35.9
14.0
262.1

2005E
935
23
2
960
85
11
1,056

Accrued expenses and others
Customers’ deposits
Deferred revenue
Total current liabilities

n.a.
n.a.
n.a.
n.a.

3.8
8.4
7.5
19.6

21.9
26.0
6.3
54.2

22
65
7
93

Share capital and reserve
Accumulated profit/(loss)
Convertible preferred shares
Total shareholders’ equity
Total liabilities and equity

n.a.
n.a.
n.a.
n.a.
n.a.

24.1
-58.6
91.6
-34.5
76.7

43.8
-47.1
211.1
-3.3
262.1

980
-17
963
1,056

Total cash
Total debt
Net cash/(debt)

n.a.
n.a.
n.a.

62.8
91.6
-28.8

200.2
211.1
-10.9

935
935

Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

Exhibit 21
Baidu Reported Cash Flow Statements (2002-2005)
Year-end Dec 31 (in RMB millions)
Net (loss) income
Depreciation
Amortization of intangible assets
Share-based compensation
Allowance for doubtful accounts
Accounts receivables and others
Customers’ deposits
Accrued expenses and others
Deferred revenue
Operating cash flow

2002A
-18.6
3.1
4.2
0.7
1.9
0.5
0.4
-7.8

2003A
-8.9
4.9
5.1
-1.3
6.3
1.6
5.0
12.7

2004A
12.0
8.9
1.1
16.5
0.6
-9.9
17.6
10.7
-1.2
56.3

2005E
30
32
3
31
2
-15
39
1
122

Acquisition of fixed & intangible assets
Capitalization of software costs
Investing cash flow

-3.7
-2.1
-5.8

-6.4
-1.6
-8.0

-37.3
-2.2
-39.5

-81
-81

New convertible preferred shares
New share issuance
Dividend payment
Financing cash flow
Change in cash and equivalents

-13.6

4.7

120.0
0.6
120.6
137.4

694
694
735

Source: Company data; CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

This document is authorized for use only in FINCE 90013 (333-632), FNCE 90023 (333-665) by Lyndon Moore from
February 2012 to August 2012.

Baidu.com, Inc.: Valuation at IPO A-197

p. 25

Exhibit 22
Baidu Pro-Forma Income Statements (2005-2010)
Year-end Dec 31 (in RMB millions)
Online marketing services
Enterprise search software
Portal search services
Total gross revenue
Less: business taxes
Net revenue
Cost of revenue
Gross profit
SG&A
R&D
Share-based compensation
Total opex
Operating profit (loss)
Other income (expenses)
EBT
Tax
Net income
Net income (ex. SVBC)
EBITDA (ex. SBC)

2005E
277
11
2
290
-19
271
-80
191
-99
-31
-31
-162
29
6
35
-5
30
61
95

2006E
532
15
1
547
-36
512
-137
375
-153
-48
-44
-245
129
14
143
-15
128
173
229

2007E
797
16
1
814
-53
762
-187
575
-221
-76
-50
-347
228
22
250
-30
220
270
343

2008E
1,099
17
0
1,117
-73
1,044
-246
798
-313
-106
-52
-471
327
31
359
-62
297
349
447

2009E
1,516
17
0
1,534
-100
1,434
-320
1,114
-364
-138
-55
-557
557
40
598
-98
500
555
683

2010E
1,843
18
0
1,871
-122
1,750
-392
1,358
-411
-165
-58
-634
723
50
774
-125
649
707
860

Gross margin (%)
EBITDA margin (%)
Operating margin (%)
Net margin (%)
Effective tax rate (%) (ex. SBC)
Effective tax rate (%)

66
33
10
21
14
7

68
42
24
32
10
8

71
42
28
33
12
10

71
40
29
31
17
15

73
45
36
36
16
15

73
46
39
38
16
15

Year-on-Year Growth (%)
Gross revenue
EBITDA (ex SBC)
Net income
Net income (ex. SBC)
Basic number of ADS (mn)
Fully diluted number of ADS (mn)
EP ADS (US$) (basic)
EP ADS (US$ (FD)

147
152
153
114
27.7
34.9
0.13
0.11

89
142
323
182
32.8
34.9
0.48
0.45

49
50
71
56
32.8
34.9
0.83
0.78

37
30
35
30
32.8
34.9
1.12
1.05

37
53
68
59
32.8
34.9
1.88
1.77

22
26
30
27
32.8
34.9
2.44
2.30

Source: Company data, CSFB Research Report, “Baidu, in Search of Excellence,” September 22, 2005.

This document is authorized for use only in FINCE 90013 (333-632), FNCE 90023 (333-665) by Lyndon Moore from
February 2012 to August 2012.

Baidu.com, Inc.: Valuation at IPO A-197

p. 26

Exhibit 23
Baidu Pro-Forma Balance Sheet Statements (2005-2010)
Year-end Dec 31 (in RMB millions)
Cash and cash equivalents
Accounts receivables
Prepaid expenses and others
Total current assets

2005E
935
23
2
960

2006E
1,131
42
2
1,175

2007E
1,416
61
2
1,480

2008E
1,770
82
2
1,854

2009E
2,301
110
2
2,413

2010E
2,884
129
2
3,016

Fixed assets – net
Intangible assets – net & others
Total assets

85
11
1,056

95
8
1,278

116
5
1,601

146
2
2,002

191
1
2,605

243
1
3,260

Accrued expenses and others
Customers’ deposits
Deferred revenue
Total current liabilities

22
65
7
93

22
112
9
142

22
163
11
195

22
212
14
248

22
256
18
296

22
300
21
344

Share capital & reserve
Accumulated profit/(loss)
Convertible preferred shares
Shareholders’ equity
Total liabilities and equity

980
-17
963
1,056

1,024
112
1,136
1,278

1,074
331
1,405
1,601

1,126
628
1,755
2,002

1,181
1,128
2,309
2,605

1,239
1,677
2,916
3,260

Total cash
Total debt
Net cash/(debt)

935
935

1,131
1,131

1,416
1,416

1,770
1,770

2,301
2,301

2,884
2,884

Exhibit 24
Baidu Pro-Forma Cash Flow Statements (2005-2010)
Year-end Dec 31 (in RMB millions)
Net (loss) income
Depreciation
Amortization of intangible assets
Share-based compensation
Allowance for doubtful accounts
Accounts receivables & others
Customers’ deposits
Accrued expenses and others
Deferred revenue
Operating cash flow

2005E
30
32
3
31
2
-15
39
1
122

2006E
128
52
3
44
3
-22
47
2
257

2007E
220
62
3
50
4
-23
51
2
369

2008E
297
64
3
52
6
-26
50
3
448

2009E
500
70
1
55
8
-36
44
4
646

2010E
649
79
58
10
-29
44
3
814

Acquisition of fixed & intangible assets
Capitalization of software costs
Investment cash flow

-81
-81

-61
-61

-84
-84

-94
-94

-115
-115

-131
-131

Net convertible preferred shares
New share issuance
Dividend payment
Financing cash flow
Change in cash and equivalents

694
694
735

196

285

354

531

-100
-100
583

This document is authorized for use only in FINCE 90013 (333-632), FNCE 90023 (333-665) by Lyndon Moore from
February 2012 to August 2012.

Baidu.com, Inc.: Valuation at IPO A-197

p. 27

Exhibit 25
Other Relevant Data for Baidu IPO Valuation
A. Beta and WACC Comparison across Major China Internet Companies (2005)
A1. Competitor Comparison
Sina
NetEase
Shanda
Tencent
Google
Alibaba/Yahoo!

Beta
1.4
1.5
1.5
1.5
1.2
1.5

WACC*
12.70%
13.30%
12.60%
13.70%
9.32%
12.38%

*Used by analysts for DCF
A2. Baidu Internal WACC**
January-03
January-04
April-04
**Baidu used to calculate fair value of stock in F-1

28%
27%
26%

B. Global Internet Valuation Comparison (2005)
P/E (x)
Google
Alibaba/Yahoo!
Sina
Sohu
NetEase
Shanda
Tencent

55.8
57.4
31.3
22.9
24.6
16.6
29.5

EV/
EBITDA (x)
30.8
27.8
18.4
21.4
20.6
12.1
24

EV/
Sales(x)
14.1
8.6
5.6
6.0
12.9
6.4
8.7

C. Baidu Risk Free Rate Assumptions Used to Calculate Options
2002
2.79%
2003
2.79%
2004
3.60%
D. Baidu Number of Shares Outstanding (for IPO in August 2005)
Total number of shares outstanding
32.3 million
Number of shares offered
4.04 million

This document is authorized for use only in FINCE 90013 (333-632), FNCE 90023 (333-665) by Lyndon Moore from
February 2012 to August 2012.

Baidu.com, Inc.: Valuation at IPO A-197

p. 28

E. China Annual Real GDP Growth: 1960-2007
Time Period
1960-1978 (pre-reform)
1979-2007 (post-reform)
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

Average Annual Growth (%)
5.3
9.8
3.8
9.3
14.2
14.0
13.1
10.9
10.0
9.3
7.8
7.6
8.4
8.3
9.1
10.0
10.1
9.9
11.1
11.4

Source for Exhibits 23-25: Company data; CSFB Research Report, “Baidu, In Search of Excellence,” September
22, 2005; Pacific Growth Equities Report, “Sohu.com, Inc.,” July 28, 2005. Official Chinese government data and
Economist Intelligence Unit.

This document is authorized for use only in FINCE 90013 (333-632), FNCE 90023 (333-665) by Lyndon Moore from
February 2012 to August 2012.