Baidu: Chinese Investigation Dragging Stock Lower

Baidu (BIDU), the largest internet search engine company in China, has come under fire as of late after one of its users, a 21 year old university student Wei Zexi, died after trying an experimental cancer treatment he found advertised on the website. Once the treatment failed he took to social media to blast Baidu for promoting false medical claims. China’s cyberspace administration is now investigating and the company has until May 31st to comply with the government.

Chinese regulators are proposing limits on health care related advertising and stringent practices for vetting marketers. Baidu has already began terminating relationships, translating to the removal of ads and some revenue.

Search revenue accounts for nearly 80% of total revenue, with a portion coming from health care. Although difficult to measure, it does put some cash flow in jeopardy of diminishing, at least in the short-term. Investor concern can visibly be seen in the recent stock price decline on the Nasdaq exchange.

Shares of Baidu (BIDU) have fallen 13%+ from the April highs, but the stock has been variable for the last year and half. The recent peak just above $200 confirmed another lower high. Combine that with the latest round of heavy selling pressure and a bearish reversal in the MACD (technical indicator), it is quite possible that we will see a retest of the $140 support level.

While the company did report better than expected Q1 earnings last month, regulatory concerns that could lead to shrinking revenue in the coming quarters and downside momentum from a “technical chart analysis” perspective are reasons to stay cautious for now (and patient). From a trading perspective, I’m considering putting on the July 15 $140/$160 bear put spread for a $6 debit, putting the reward/risk ratio north of 2:1.