The cost of bearish Baidu Inc options fell to a five-year low on speculation China's largest Internet search engine will boost mobile advertising revenue and halt a three-month slump in its shares.

Puts protecting against a 10 percent decline in Baidu on Friday cost 1.4 points more than calls betting on a 10 percent gain, according to data on three-month options compiled by Bloomberg. The price relationship, known as skew, fell to 0.81 on April 24, the lowest since April 2008. US-traded shares of Baidu slumped 21 percent from the end of January through April on concern the company won't be able to maintain its leadership in the desktop Internet search market.

Baidu is extending its services to mobile devices as profit growth slumps to the slowest pace since its shares were listed in 2005. The company said this month it's buying PPS Net TV's Internet video business and will combine it with iQiyi.com, which it bought last year, to create China's largest online video website for mobile users and compete with dominant player Youku Tudou Inc.

"The acquisitions are positive," Mari Oshidari, a Hong Kong-based Asia market strategist at Okasan Securities Group Inc, said by e-mail on May 15. "We can expect Baidu to gain synergy and expand its market share in the online mobile-video business. Valuation is cheap as well and downside for the share price is limited."

Rising competition

Baidu's American depositary receipts plunged 24 percent in the past 12 months and touched the lowest since September 2010 on April 5 as Baidu grappled with rising competition. Baidu is trading at 18.4 times estimated earnings for 2013 compared with the average of 44 times in the past five years, according to data compiled by Bloomberg.

Baidu reported on April 25 that first-quarter net income climbed 8.5 percent to 2.04 billion yuan ($332 million), short of analyst estimates. The profit increase compares with average quarterly growth of about 60 percent in 2012.

The results were disappointing and reflected how increased spending for mobile products and other investments eroded profitability, Barclays Plc said in a research note the following day. Gross profit margins fell to 65 percent in the first quarter from 71 percent a year earlier, Baidu's results showed.

"Baidu is already a dominant search engine in China, so people are concerned there will be limited upside in terms of market share," Masahiko Ejiri, a Tokyo-based fund manager for Mizuho Asset Management Co, which oversees about $45 billion, said in a May 14 phone interview. "Most of its investments are in the initial stage and new businesses aren't generating profits yet."

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Baidu's share of search-engine queries in China dropped to 81 percent in March from 86 percent a year earlier, according to data compiled by Bloomberg Industries. Qihoo 360 Technology Co had a 9.2 percent share in March compared with 4 percent when it started offering services in August, the data showed.

Implied volatility, used to gauge the cost of options, for three-month contracts with an exercise price 10 percent below Baidu slipped 23 percent this year to 34.8 on Friday, according to data compiled by Bloomberg. The measure for calls 10 percent above lost 21 percent to 33.38 during the same period.

Traders have accumulated the most bullish Baidu options since January. There were 169,835 calls outstanding as of May 14, or 25 percent more than the number of puts, according to data compiled by Bloomberg. All four most-owned contracts were bullish. May $95 calls, with an exercise price 2.5 percent above Friday's close, had the largest open interest, followed by June $100 calls and January $100 calls.

Mobile Internet

Kaiser Kuo, a Beijing-based spokesman for the company, declined to comment on the options trading.

The HSI Volatility Index, which measures the cost of options on Hong Kong's Hang Seng Index, gained 4 percent to 15.69 on Friday. In the United States, the Chicago Board Options Exchange Volatility Index slipped 4.7 percent to 12.45 on Saturday, while Europe's VStoxx Index, which tracks Euro Stoxx 50 Index derivatives prices, added 0.3 percent to 16.31.

Chairman and Chief Executive Officer Robin Li said last month Baidu will buy mobile applications that supplement its search products, which had more than 100 million daily active users as of the first quarter.

Spending in the mobile Internet advertising industry in the Asia-Pacific region will increase 33 percent to $3.7 billion in 2013, according to data compiled by Bloomberg Industries. Total revenue from online advertising in the region will rise 16 percent to $29 billion this year, the data showed.

Biggest purchase

The Beijing-based company, whose cash and equivalents dropped to 8.73 billion yuan as of March 31 from 11.88 billion yuan at the end of last year, has made acquisitions valued at about $700 million in the past two years, according to data compiled by Bloomberg. Baidu is paying $370 million for the PPS Net TV's Internet video business, its biggest purchase.

"While this latest acquisition is not enough to truly move the needle in terms of earnings, we believe it is critical in that it gives investors something to consider other than deterioration of market share," David Riedel, president of Riedel Research Group Inc in New York, said by e-mail on May 14. "The market has been overly concerned about what we consider to be truly inconsequential competitive threats."

'Significant change'

A move by Alibaba Group Holding Ltd, China's biggest e-commerce company, to buy a stake in Sina Corp's Twitter-like Weibo service could weaken demand for Baidu's e-commerce search engine, Citigroup Inc analysts led by Muzhi Li wrote in a research note on April 30. Qihoo is hiring hundreds of engineers to develop its Internet browser and mobile-search functions as it competes with larger rivals such as Baidu and Tencent Holdings Ltd, Chairman Zhou Hongyi said in February.

Competitive threats to Baidu aren't as bad as investors fear, Ma Yuan, a Beijing-based analyst at Bocom International Securities Ltd, said by phone on May 15. The brokerage expects Baidu's mobile investments to start contributing positively in 2014, she said.

(China Daily 05/20/2013 page14)