Baidu's Risks Are Homegrown
The Asian Wall Street Journal
2005-08-09

Hurdles Lie in China＊s Regulatory Maze, Google＊s Ambitions

Hong Kong - Behind the euphoria over Chinese Web outfit Baidu.com Inc.'s stock-market debut is a company that operates a lot like Google Inc. - but could face some uniquely Chinese hurdles as it tries to expand.

Search engine Baidu, which has its headquarters in Beijing, garners revenue the same way Google does, by selling keyword-based advertisements, or paid links, most of which pop up when people perform a search on the site.

But Baidu, whose American depositary shares more than quadrupled in their first day of trading on the Nasdaq Stock Market Friday and then eased 5.8% yesterday, is operating on the furthest frontier of the Internet. It faces brutal competition and possible heavy government regulation, even as the legitimacy of its own content has come under legal challenge.

One risk is from Google itself. It was the listed owner of 2.6% of Baidu as of Friday, and Baidu's Web site, in Chinese, looks remarkably similar to Google's sleek, uncluttered home page.

Despite speculation that Google was considering increasing its stake in Baidu - a substantially more costly proposition since the initial public offering - the biggest search provider in the U.S. also is engineering an expansion in China that could prove expensive for Baidu. Google has been battling Microsoft Corp. to hire a high-profile former executive of the U.S. software giant to lead its Chinese operations.

Frank Au, the managing director of mergers-and-acquisitions concern Latitude Capital Group in Hong Kong, says Google and Baidu are going head-to-head in the Chinese search market, even though Google hasn't ramped up its Chinese operations enough to be able to profit from its search traffic.

Internet companies in China are fighting over a small pie. The Chinese Internet-search market attracted total ad revenue of just $148 million in 2004, according to iResearch Inc. of Shanghai. While China's advertising industry is booming, many major advertisers focus big campaigns on banner ads posted on Internet portals such as those of Sina Corp. and Sohu.com Inc., which remain more popular than search sites such as Baidu.

"We treat the portals as a national medium, after TV and print," says Ralph Szeto, the China director of WPP Group's mOne unit, which buys media space for clients' ads. "But user habits are changing toward searching," he adds, giving sites such as Baidu a niche among an estimated 600,000 small and midsize Chinese companies that pay anywhere from three fen to five yuan per advertising link. The yuan trades at about 8.1 to the dollar.

Moreover, most Chinese can't afford computers and the country's electronic-commerce market remains immature. Many Chinese prefer to download entertainment and communicate with friends through mobile phones, which are less expensive than computers.

In the future, "Internet content will merge with mobile-phone technology," putting even more of a premium on media companies that can offer attractive content, says Peter Tan, director of consumer insights for Interpublic Group's McCann Worldgroup ad agency in China.

Baidu could be running into legal trouble over one of its big content advantages: its focus on online music. About 20% of the searches on the site are for a service that enables users to easily search for "deep links" to unlicensed MP3 music and other video files stored on outside servers.

Deep links connect readers directly to a file, bypassing the front page of a Web site. This summer, five media companies filed lawsuits against Baidu, according to May-Seey Leong, the Asian regional counsel for the International Federation of the Phonographic Industry.

"We have a lot of focus on Internet piracy in China," says Ms. Leong, who points out that the industry sent 2,400 cease-and-desist letters to Chinese Web sites last year.

Moreover, all Internet businesses in China face the threat of regulatory clampdowns from China's government, which maintains unpredictable control over all media. Last year Beijing targeted wireless-content providers, some of which were accused of using shoddy marketing and billing practices.

Several companies, including Sina and Sohu, were hit with sanctions or fines, which hurt the companies' stock prices. In recent months, the government has gone after racy and violent online computer games and is introducing a system through which it "recommends" certain games.

In the "risk factors" section of its IPO prospectus, Baidu noted that its business could be hurt if the government enacted laws governing anything from online advertising to online news to Web video-broadcasting.

By Rebecca Buckman and Geoffrey A Fowler