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Friday, 31 October 2014

Downwardly mobile margins

Profit first casualty in China’s mobile ad war

China’s online giants are tooling for the mobile ad wars, and profit will be the first casualty. Of 560 million web users, three-quarters are already using smartphones, threatening massive disruption for companies who depend on online advertising revenue. Baidu, the dominant search provider that reports earnings on Feb. 4, has most to prove, and most to lose.

Mobile ad revenue in China is small but fast-growing, and should almost triple by 2015, according to iResearch, to 3.5 billion yuan ($560 million). Advertisers tend to be wary of paying up at first, but encouraging fourth-quarter earnings from U.S. internet groups Google and Facebook suggest that changes as mobile matures.

Baidu is the default search on most of China’s Android-based smartphones, but that’s not enough. Apps like Dianping, a location-based listings service, are drawing users away from traditional search, while small screens can return only a few results at a time. Baidu’s track record of growing annual revenue per user by 38 percent for the past four years may not survive the transition.

For now the priority is to capture the biggest share of users’ time. Tencent has a headstart. Its messaging application, WeChat, has notched up a phenomenal 300 million users in just two years. Baidu, meanwhile, is relying on scale more than ideas. It is investing some 10 billion yuan on a new cloud computing centre and offering users and developers storage.

Baidu’s route looks the costlier one. The cloud demands top-notch security products, which it will probably have to offer users for free. Spread the bill for that new data centre over five years and Baidu’s total costs would increase by 50 percent from 2012’s run rate. A cash pile of $4.5 billion gives Baidu options to buy rather than build, but it may end up overpaying to defend its market position.

The upshot is that Baidu’s operating margins of 53 percent in the last quarter will start to look more like Google’s, which are around half that. While its bottom line probably grew four times as fast as Google’s in 2012, the Chinese search giant trades at just a 15 percent premium to its U.S. rival, based on 2013’s earnings. Investors rightly expect things to get vicious.

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Baidu, China’s biggest search engine provider, is due to report its fourth-quarter earnings after the market’s close on Feb. 4, U.S. time. Analysts expect revenues in the quarter to increase 43 percent year on year to 6.2 billion yuan ($1 billion), according to Reuters Eikon, compared with 52 percent growth in the previous quarter.

For the full year, analysts expect earnings of 10.4 billion yuan, a 58 percent increase on 2011’s figure.

Tencent, which provides gaming and social networking, said on Jan. 28 it was restructuring its mobile division, and handing responsibility to Ren Yuxin, the company’s chief operating officer. Mobile revenues made up 8.2 percent of Tencent’s revenues in the three months ending Sept. 30 2012. WeChat, its online messaging application, had 300 million users in January, two years since its launch.

China’s mobile internet users numbered 420 million at the end of December 2012, having increased 18 percent in a year, according to the China Internet Network Information Centre. They now make up 74 percent of the country’s total web users, compared with 69 percent in 2011. The online advertising market is estimated to grow 53 percent in 2013 to 1.9 billion yuan, according to consultancy iResearch, and reach 3.5 billion yuan by 2015.

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