Baidu Inc, China's largest search engine, will increase marketing expenditures for the rest of the year to counter competition from rival Qihoo 360 Technology, which may further put the brakes on profit growth.
Baidu posted on Friday its slowest quarterly profit growth since end-September 2008, citing a rise in traffic acquisition costs, or what a search engine pays to partner websites and software applications to show its search box or results.
Traffic acquisition costs for the quarter were equivalent to about 10.2 percent of total revenue, up from 7.8 percent a year ago, and Baidu said it expects that margin to rise until the end of the year.
"We have said very clearly that this year we will put a big emphasis on sales and marketing promotional expenses to push our products through the systems," Baidu's chief financial officer, Jennifer Li, said on an earnings conference call.
"At this stage of the company's life, we do not focus on managing toward a specific margin target," Li said. "We target strategically important areas that make sense for us to invest."
Baidu disappointed investors and reported net income for the quarter ended March 31 increased 8.5 percent year-on-year to $328.9 million, or 95 cents per American Depositary Share, short of the $1.03 per ADS analysts had expected. It was the second consecutive quarter that profit growth eased.
Revenue in the first quarter rose 40 percent to $961 million, also short of the $969.3 million expected by analysts polled by Thomson Reuters I/B/E/S.
"It was the bottomline that people were disappointed about, in terms of the high expenses," said Dick Wei, a Hong Kong-based JP Morgan analyst.
Qihoo's share of the search market remains relatively small compared to Baidu's 80 percent holding, but it has ramped up its search monetization products this year to better compete.
Industry analysts warn that rapidly changing user habits and competition in the search market could weigh on revenue.
Shares of Baidu, which have fallen about 12 percent since the start of the year, were down more than 8 percent at $84.83 in after-hours trading on Thursday.
In addition to the increase in costs, the consolidation of the results from Baidu's loss-making online video unit, iQiyi, also ate into profit margins.
Analysts said they do not envision iQiyi being profitable in the near future given the high costs of the online video sector.
In the first quarter, content costs associated with iQiyi were at 1.6 percent of revenue. Li said she expects content costs to trend downward for the rest of the year.
Baidu's sales and marketing costs increased 77 percent while research and development costs rose 83 percent for the quarter.
For the second quarter, Baidu estimated revenue of $1.187 billion to $1.216 billion. Analysts polled by Thomson Reuters I/B/E/S had an average forecast of $1.2 billion.
On Thursday, local media reported that Baidu was in the process of acquiring Chinese online video firm, PPS Net TV, for between $350-$400 million. Baidu declined to comment about the report.
(Additional reporting by Alexei Oreskovic in San Francisco; Editing by Richard Chang and Miral Fahmy)