Cloud becoming a Material Long- term Driver for Baidu As Q1 2022 Revenue Beat

Business Strategy & Outlook:

Baidu’s online advertising business accounted for 79% of Core revenue in 2020 and will be the main source of revenue in the medium term given its dominant market share for search engines, but unless it can develop another industry-leading business, it could face long-term challenges for advertising dollars from growing competitors such as Tencent and Bytedance. In recent years, the firm developed its own ecosystem by creating its own Baidu app that incorporates smart mini-programs like Tencent’s WeChat to attract organic user growth but the flagship app has reached 580 million monthly active users in second-quarter 2021, increasing 9% year on year and 4% sequentially, signaling deceleration. Therefore, the signs of a plateau emphasize the importance of being able to commercialize other businesses, but success is far from certain.

Baidu is transforming its identity by investing in AI firms, mainly AI cloud and autonomous driving, but whether these are commercialized successfully remains to be seen. There are encouraging signs of its AI cloud monetization having seen a 75% CAGR from 2018-20, now accounting for 14% of Core revenue in second-quarter 2021. However, despite sharp growth, Baidu has to face competition in the cloud from industry leaders Alibaba, Huawei and Tencent, which all have greater market share than Baidu. Baidu has invested in other emerging technologies, including speech recognition, AI chips, and autonomous driving. Despite a potential total addressable market for autonomous driving that is 9 times its online advertising per management, commercial success is highly uncertain as revenue remains immaterial, and mass scale adoption or time-to-market are unclear. Its streaming video service, iQiyi, continues to be a margin drag on Baidu’s business due to a high content cost. The business constantly needs to develop or acquire new content to prevent customer churn. We’re less confident of its outlook than the Core product due to a low barrier to entry and numerous competitors. Membership has remained stagnant at 105 million to 106 million subscribers for the last five quarters and therefore, long-term growth is limited.

Financial Strengths:

Baidu’s balance sheet remains very well capitalized, with around CNY 163 billion in cash and short-term investments to support CNY 76 billion in total debt as of December 2020. Its free cash flow was CNY 3.9 billion in 2020, which is sufficient to fund operations and maintain its moat through investments in new products. As of fiscal 2020, Baidu had an EBITDA/interest coverage ratio of over 50 times. Given the cash-rich nature of the search business, Baidu might initiate repaying interest expense and debts when they are due. As of January 2021, Moody’s maintained Baidu’s A3 rating and changed the outlook from positive to stable.

Bulls Say:

Baidu is strengthening its mobile ecosystem with search, livestreaming, and mini programs, helping to create a closed-loop experience for users to acquire information and make transaction.
Baidu is a leader in AI with autonomous driving in terms of number of miles tested and the number of driving licenses in China. Baidu’s AI cloud has also grown significantly in 2020 at 44% year over year, with signs of momentum.
Sitting on a cash pile of over CNY 100 billion, Baidu has ample dry powder to invest in technology, particularly in AI, as well as merger and acquisition opportunities.

Company Description:

Baidu is the largest internet search engine in China with 84% share of the search engine market in September 2021 per web analytics firm, Statcounter. The firm generated 62% of revenue from online marketing services from its search engine in 2020. Outside its search engine, Baidu is a technology-driven company and its other major growth initiatives are artificial intelligence cloud, video streaming services, voice recognition technology, and autonomous driving.

(Source: Morningstar)

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