TEXT-Fitch Rates China's Baidu 'A'; Proposed Notes 'A(EXP)'
SEOUL/SYDNEY/SINGAPORE, November 06 (Fitch) Fitch Ratings has assigned Baidu Inc.'s (Baidu) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) of 'A'. The Outlook is Stable. The agency has also assigned Baidu's proposed USD senior notes an expected rating of 'A(EXP)'. A full rating breakdown is provided below.
The ratings reflect Baidu's dominance in the internet search market in China with an over 85% traffic market share. The ratings also benefit from strong profitability and balance sheet reflecting its ability to monetise internet traffic, through a proven performance-based, online marketing service to half a million advertising customers targeting hundreds of millions of Chinese internet users.
Fitch believes that technological innovation plus high levels of brand recognition and consumer satisfaction have enabled Baidu consistently to increase its market share in a rapidly growing market. The company's brand, intellectual property and market share present high barriers to entry for potential competitors. The company also has managed its relationship with the government and other regulatory bodies well.
Baidu has generated free cash flow (FCF)/sales of around 40% for the period of 2008 to 2011 and continued to maintain a net cash position as of end-September 2012. Fitch expects Baidu to maintain strong financial flexibility with sound profitability, ample liquidity and prudent leverage over the medium term.
Fitch notes that Chinese law restricts foreign equity ownership in internet, online advertising and employment agency companies in China. Baidu, registered in the Caymen Islands, operates its websites in China through consolidated affiliated Chinese entities with whom it has contractual relationships. These variable interest equity (VIE) arrangements are a credit weakness as they may not be as effective in providing control as direct ownership. However, Fitch notes that VIE structures are the usual mechanism for overseas investors to participate in sectors which are subject to China's investment restrictions.
In addition, Fitch takes comfort from the fact that Baidu generates over 70% of revenues from, and keeps almost all the cash and assets within, its wholly owned subsidiaries in China rather than the contractually controlled, consolidated affiliated entities. The agency is also reassured by the alignment in Baidu's and affiliates' objectives and the company's continuing good relationship with the government and regulatory authorities.
The proposed USD senior notes are rated at the same level as Baidu's rating as they represent direct, unconditional, unsecured, and unsubordinated obligations of the company. However, as is typical in Chinese global bond issues the notes will be structurally subordinated to all existing and future obligations and other liabilities of Baidu's subsidiaries. Fitch does not believe this risk to be material given that most of Baidu's consolidated debt will be at the parent level.
The notes' final rating is contingent upon receipt of final documents conforming to information already received.
List of rating actions:
Long-Term Foreign- and Local-Currency IDRs assigned at 'A'; Outlook Stable
Foreign-currency senior unsecured rating assigned at 'A'
Proposed USD notes assigned at 'A(EXP)' What could trigger a rating action?
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Evidence of greater government, regulatory or legal intervention leading to an adverse change in the company's operations, profitability or market share
-Decline in operating EBIT margin to below 10% (52.7% in Q312) -Decline in pre-dividend FCF/sales ratio to below 10%
-Increase in funds from operations-adjusted leverage to above 2x (0.5x at end-2011)
Positive: For the short-to-medium term, Baidu's rating is at its ceiling and takes into account Fitch's expectation of profit growth. Fitch may consider an upgrade if the company develops businesses that materially diversify cash generation away from operations which are subject to Chinese government and regulatory risk.
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