Is Baidu’s $1 Billion Share Buyback Program a Good Deal for Shareholders?

By Sean O’Reilly

Buffett on Buybacks“There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds -- cash plus sensible borrowing capacity -- beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated.”-- Warren Buffett, 1999 Berkshire Hathaway Chairman’s Letter to Shareholders

A Rough Quarter and a Billion Dollar Buyback

For the quarter ended June 30, 2015:• Total revenues up 38.3% year over year to $2.67 billion• Operating profit fell 2.5% to $559.6 million• Net income slid slightly to $590.6 million• Mobile search monthly active users increased 24%

year over year to 629 million• Traffic acquisition costs as a percentage of revenues

dropped from 13.5% of revenues to 12.7%

A Rough Quarter and a Billion Dollar Buyback

• The main drag on profitability was investments in the company’s “O2O” initiative

• O2O stands for “online to offline”, which basically means helping mobile internet users buy goods at physical stores

• Baidu aims to be a leader in this burgeoning industry despite fierce competition

• O2O & Other division reduced operating margins by 25.3%• Following the release, Baidu announced a $1 billion share

repurchase program

What goes up must come down…

What Would Warren Do?

Is Baidu’s share repurchase program a prime example of intelligent capital allocation, or a ploy to placate shareholders after a terrible quarter?

Best Use of Shareholders’ Capital?

There are four possible uses for shareholders’ capital:–Capital investments–Dividends– Share repurchases–AcquisitionsDoes the $1 billion share repurchase make

economic sense?

Best Use of Shareholders’ Capital?

• Companies repurchasing shares need to be able to prove that it is the best use of capital – instead of paying a dividend or expanding

• This is tricky because we are on the outside looking in on Baidu’s operations

• Comparing Baidu’s valuation to other leading internet search giants is instructive

The “Google” of China

• China’s Internet market is notoriously restrictive and Baidu’s leading position there is secure for this reason

• China’s middle class and Internet use will only grow from here

• Growth initiatives like “online to offline” investments offer growth potential in addition to this

It’s All Relative

Baidu Inc Alphabet Inc

Market Capitalization $50.64 billion $444.7 billion

Trailing Free Cash Flow $2.06 billion $11.42 billion

Forward Price to Earnings Ratio 25.23 21.3

Forward Revenue $10.63 billion $73.43 billion

5 Year Forward Earnings Growth

Rate24.16% 14.17%

Source: S&P Capital IQ

Foolish Takeaway

• Baidu trades for just 25 times forward earnings estimates and 24 times trailing free cash flow

• Likely to grow faster than Alphabet for foreseeable future

• Has a dominant position in a burgeoning Internet market that stands to be much bigger than the U.S.

• Share buybacks announced only after shares dropped because of short term concerns

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