Share price as of Thursday's close:

$27

Share price now:

$122.54

Change:

353.9%

Volume:

22.6 million shares

Intraday high:

$151.21

Intraday low:

$60.00

in Chinese?

Baidu.com

Shares of China's No. 1 search engine rocketed 354% to $122.54 Friday in Baidu.com's initial public offering. The company's 4.04 million American depositary shares priced at $27 each late Thursday, raising a total of $109.1 million, but explosive demand for a piece of the web site that has drawn comparisons to its Silicon Valley counterpart sent the stock nearly five times higher. The steep appreciation immediately raised questions about whether Baidu.com, which is significantly smaller than Google, deserves such a rich valuation.

"I think the stock's rise is outrageous," says Fariborz Ghadar, director of the Center for Global Business Studies at Penn State University. "This is another one of those bubbles. At the $27 offer price it was trading at 64 times sales. Even though its sales tripled last year, that doesn't justify a 64 price-to-sales ratio." (Ghadar doesn't own shares of Baidu.com.)

Baidu.com's final offering price was above Wednesday's range of $23 to $25, and that range had already been boosted from $19 to $21. Based on first-day performances, Friday's meteoric climb makes Baidu.com far and away the best IPO of 2005, the second-best foreign IPO ever and one of the top-20 of all time, according to Thomson Financial. Google's stock debuted on Aug. 19 at $85 and ended its initial trading session at $110.34; shares now change hands at $292.35.

"It's a tsunami of retail interest," says Francis Gaskin, editor of Los Angeles research firm IPOdesktop.com. "The guys doing the pricing priced it for the fund market and they didn't realize the huge wave of retail interest. And the retail investors don't have a clue about the valuation." Goldman Sachs, Credit Suisse First Boston and Piper Jaffray underwrote the offering. (Gaskin doesn't own shares of Baidu.com; IPOdesktop.com doesn't have an investment-banking relationship with the company.)

Five-year-old Baidu.com was the most frequently used search engine in China in 2004, according to a survey conducted by iResearch, a research firm specializing in China's Internet industry. As of July 31, Baidu.com was the second-largest web site in China and the sixth-largest web site globally, as measured by user traffic, according to Alexa.com, an Internet research firm.

As they used to say in the dot-com era, Baidu.com has managed to monetize those eyeballs too. Net revenues have grown ten-fold over the past two years, to $13.4 million in 2004 from $1.3 million in 2002, for a compound annual growth rate of 225%. For the March quarter, the company posted a profit of $300,000 on sales of $5.2 million. As for the June quarter, Baidu.com estimates net income surging 384% over the previous quarter to $1.5 million, and revenues up 53% sequentially to $8.4 million. The growth is enough to impress even Google, which has a 2.4% stake in Baidu.com.

"The fact that Google has an ownership stake and the fact that Baidu.com didn't sell out to Google when it showed interest was a big deal and raised its profile," says Ling Liu, vice president at Cathay Funds, a private equity fund dedicated to investing in China. (Liu doesn't own shares of Baidu.com; Cathay Funds com doesn't have an investment-banking relationship with the company.)

Baidu.com's success signals that investors are buying into the online potential of China. IResearch predicts the number of Internet search users in China will grow at an annual rate of 27.5% to 187 million in 2007, from 115 million in 2005. In 2004, there were 84 million users.

But while promising, China has a long way to go before it catches up with the U.S. a reality that raises questions about the worth of Baidu.com. Including 28 million in Class B shares, the company now has a market capitalization of $3.92 billion vs. Google's $83.97 billion.

"The whole online e-commerce market in China last year was $130 million," says IPOdesktop.com's Gaskin. "So, [Baidu.com's market cap] is approaching 30 times the entire market in 2004. And it's just a regional market. Chinese is not the international language. People are buying the story that it's the second largest web site in China's growing market. But they forget it's very much a one-country wonder."

During Gaskin's unscientific research, he asked Chinese reporters if they used Baidu.com. Most said "yes," but that they like Google better because it has fewer ads. Google introduced a Chinese language interface in September 2000.

Renaissance Capital, an independent research firm in Greenwich, Conn., points out several key differences between Baidu.com and Google. Compared with Google's direct sales model, Baidu.com relies heavily on a network of more than 200 regional distributors for sales, billing and collections. While this common practice in China has enabled Baidu.com to grow its advertiser base rapidly, none of these arrangements are long-term and many are non-exclusive. China's regulatory landscape with respect to Internet services is also an issue. Censorship is common and the Chinese government is continuously modifying and/or enacting laws that can have a major impact on an emerging industry such as Internet search, says Renaissance.

Baidu.com also generates an estimated 21% of its user traffic from MP3 searches, many of which are illegal. This exposes the company to potential copyright-infringement claims, especially if there is an industry crackdown in China on the piracy of music, adds Renaissance. In June, Shanghai Busheng Music Culture Media sued Baidu.com, alleging the company allowed the unauthorized downloads of 53 songs. Beijing New Picture Film, copyright owner of "House of Flying Daggers,'' also sued charging that Baidu.com allowed users to download the movie for a fee.

Quote:
"It's a speculative fever right now," says Raymond Lin, portfolio manager with Tricera Capital, a San Francisco hedge fund specializing in Asian markets. "It doesn't make any sense. But as we saw in previous bubbles, that doesn't mean it can't keep going and make people money in the short term as they profit off of the greater fool. But if you're a long-term trader looking for valuation and the worth of the business based on its general future profits and cash flows, this is a ridiculous price. People might latch onto Google owning a stake, but they got it for less than $10 a share. At the end of the day, what is the price relative to the profit it will generate in the future? The current valuation is way ahead of the most optimistic assumptions." (Lin doesn't own shares of Baidu.com; Tricera Capital doesn't have an investment-banking relationship with the company.)