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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 Acquisitions Does 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 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