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Baidu, Inc. (NASDAQ:BIDU)

Q4 2009 Earnings Call Transcript

February 9, 2010 8:00 pm ET

Executives

Victor Tseng – IR

Robin Li – Chairman and CEO

Jennifer Li – CFO

Haoyu Shen – VP, Business Operations

Peng Ye – COO

Analysts

Dick Wei – JP Morgan

James Mitchell – Goldman Sachs

Ming Zhao – SIG

Eddie Leung – Banc of America

Catherine Leung – Citigroup

Wallace Cheung – Credit Suisse

Eric Wen – Mirae Asset

Aaron Kessler – Kaufman Bros.

Richard Ji – Morgan Stanley

Yu Jin – CICC

Elinor Leung – CLSA

Vivian Li – Piper Jaffray

Stephen Ju – RBC Capital

Jake Li – Guotai Junan

Eric Wen – Mirae Asset

Operator

Hello and thank you for standing by for Baidu's fourth quarter and full-year 2009 earnings conference call. At this time, all participants are in listen-only mode. After management's prepared remarks, there will be a question-and-session. Today's conference is being recorded; if you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to your host for today’s conference, Mr. Tseng of Baidu. Please proceed.

Victor Tseng

Hello everyone and welcome to Baidu's fourth quarter and full-year 2009 earnings conference call. Baidu's earnings release was distributed earlier today and you can find a copy on our website as well as on newswire services.

Today, you will hear from Robin Li, Baidu's Chief Executive Officer, and Jennifer Li, Baidu's Chief Financial Officer. After their prepared remarks, Robin and Jennifer will be joined by Haoyu Shen, Senior Vice President of Business Operations, to answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risk and uncertainties include, but are not limited to those outlined in our public filings with the SEC, including our Annual Report on Form 20-F. Baidu does not undertake any obligation to update any forward-looking statement except as required under applicable law.

Our earnings press release and this call include discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited mostly directly comparable GAAP measures and is available on our IR website at ir.baidu.com.

As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on Baidu's IR website.

I will now turn the call over to Baidu's CEO, Robin Li.

Robin Li

Hello everyone and thank you for joining us today. We are pleased to have ended 2009 with another quarter of solid results. In an initially challenging and later transitional year, I am proud of the strength, dedication and strong execution of our team. Baidu continues to innovate and improve our products to drive the development and growth of the search engine market.

One of the exciting developments for us this past quarter was the better than expected transition to Phoenix Nest. All keyword options have been conducted on Phoenix Nest since the migration was completed on December 1 and customer feedback continues to be encouraging.

Now, our focus is two-fold. One, further educating customers so that they can realize the full benefits of the new platforms, meaning tools and features. And two, optimizing the Phoenix Nest algorithm. So as we focus on this element, we expect customer acceptance to continue to ramp up gradually in the quarters ahead. We are optimistic about the positive impact this new platform will have on our users and customers as well as our monetization capabilities.

In Q4, we continued to witness the percentage increase of revenue coming from large customers who have tended to be the earliest beneficiaries of Phoenix Nest. We look forward to growing this business as large customers increasingly value the measurable ROI of our P4P platform and the enhanced tools that Phoenix Nest provides.

During the fourth quarter, we also remained focused on improving search experience by Baidu open search platform code named Aladdin. Today, I am pleased to say that a big portion of our search queries generate dynamic results from Aladdin. These results include both content and applications from external providers as well as user-generated content from Baidu's own verticals.

I'll give you an example. Many of you are aware that Chinese New Year is right around the corner and hundreds of millions of people will be traveling home and spend holidays with family and friends. This year, users will go to Baidu.com and search for (inaudible) or train ticket will be met with a control panel where they can input departure and destination locations, right on the Baidu search result page and our engine will deliver an updated timetable. This is just one example.

We have developed many more capabilities on Aladdin that allow our users to access comprehensive information or resolve their needs through various application layers. This sort of applications are part of the vision of box computing which aims to elevate the traditional web search for it becomes ubiquitous and an even more important part of our user's lives.

(inaudible) of emphasizing the development of useful products that fulfill user needs; we continue to push ahead on this front by improving our existing verticals such as Baidu Map and Baidu Encyclopedia. Both of these, in fact, were recently moved to the Baidu Homepage which reflects their increasing popularity.

And we made stride in our mobile search strategy, entering partnerships with leading telecom carriers, handset manufacturers to provide mobile search technology and access to popular Baidu verticals [ph]. A recent example is that Motorola has integrated Baidu as the default search engine on all of their Android phones sold in China.

We are also witnessing strong growth in our mobile search traffic. In fact, Baidu

Post Bar is one of the most popular and fastest-growing mobile applications for Chinese wireless Internet users.

Now, let's move into some of our current strategic initiatives. As China's Internet base continues its rapid growth, we are seeing new areas for growth that complement our existing strategy. In developing these new areas, we are choosing to cooperate with experienced partners whose insight can help us develop the best possible offerings. An example of this is the completely licensed online video service we are creating. Mr. Gong Yu, an Internet veteran, will be heading up this independent company.

We believe search engines are the biggest beneficiaries of e-commerce activities. So, we do our best to cultivate e-commerce in China. On this front, you have seen that we recently announced our partnership with Japan's leading B2C platform, Rakuten. By leveraging Baidu's unique vantage point on China's Internet users and Rakuten's expertise in e-commerce, this joint venture aims to fill the increasingly sophisticated online shopping needs of merchants and consumers.

Having just celebrated our tenth year anniversary last month, we are reminded of how far we have come. Today, according to iResearch Q3 data, Baidu has captured over three-fourth of traffic share in China, but this is just a beginning. China's more than 384 million Internet users translate to less than 30% penetration rate and with a potential market of 40 million SMEs in China, of which we currently work with approximately 317,000, we have plenty of room to grow.

As our SME customers become more sophisticated search engine marketers through Phoenix Nest's analytical and targeting tools to enhance ROI, we have reason to look forward to growth in customer spending. We are optimistic about the growth opportunities for 2010 and beyond.

Today, while there have been some changes at the senior level, with Haoyu and Wang Zhan 's promotion and Peng and Yinan's departures, I am confident we have the right team and strategy in place to bring value to our users and customers. Our foundation is stronger than ever and we will invest accordingly to meet the challenges and capture the opportunities ahead.

With that, I will turn the call over to Jennifer for financial highlights.

Jennifer Li

Thank you, Robin. Hello everyone. Let me take you through our fourth quarter and full-year 2009 financials before taking your questions. The amounts mentioned are in RMB unless otherwise noted.

For the fourth quarter, total revenue was RMB1.3 billion, representing a 40% increase year-over-year. Total revenue for the full-year 2009 were RMB4.4 billion, an increase of approximately 39% from 2008. During the quarter, Baidu had approximately 223,000 active online marketing customers, a 13% increase from the corresponding period in 2008 and a 3% increase from the previous quarter. Revenue per online marketing customer for the fourth quarter was approximately RMB5,700, a 24% increase from the corresponding period in 2008 and a decrease of 3% from the previous quarter. For the full-year 2009, active online marketing customers increased by 12% and revenue per online marketing customer increased by 25% over the full-year 2008 figures.

Traffic acquisition cost as a component of cost of revenue in Q4 was RMB202 million or 16% of total revenue as compared to 14.6% in the corresponding period in 2008 and 15.3% in the third quarter of '09. The slight sequential increase over Q3 reflects normal market fluctuations. Full-year 2009 TAC as a percent of revenue was 15.7%, up from 13.1% from 2008, reflecting growing Baidu Union contribution to revenues. In 2010, the focus will be on drawing quality traffic from partners.

Bandwidth cost and depreciation cost as a percent of revenue both decreased in the fourth quarter compared to the year-ago period, primarily due to improved equipment efficiency and scalability of our network.

Selling, general and administrative expenses in Q4 were RMB222 million, an increase of 26.5% year-over-year. Total SG&A expenses for 2009 were RMB804 million, a 22% increase from 2008, mainly due to increased marketing expenses and compensation cost.

R&D expenses in Q4 were RMB124 million, an increase of 45% over the year-ago period, primarily due to increased headcount. Total R&D expenses for 2009 were RMB423 million, a 48% increase from 2008, reflecting continued investment in R&D capabilities.

With the transition to Phoenix Nest now largely behind us, we are focusing more on selling and marketing. In 2010, we will continue to invest in both sales and marketing and R&D as we add headcount and drive new initiatives.

Share-based compensation expenses, which were allocated to related operating expenses, decreased in aggregate to RMB19 million in the fourth quarter from RMB21 million in the corresponding period in 2008. SBC for 2009 increased 3% over 2008 level.

Operating profit for Q4 was RMB462 million, an increase of 52% over Q4 2008. Operating profit for the full-year '09 increased 46% from '08.

Total headcount as of December 31, 2009, was about 7,300; roughly 300 more than the previous quarter. The increase in headcount mainly comes from sales and R&D.

Income tax expenses was RMB71 million for the fourth quarter. The effective tax rate for the fourth quarter was 14.2% compared to 9.1% last quarter. The increase from last quarter was mainly due to tax benefit we received in Q3. For the full year, our effective tax rate was 11.8% compared to 10% in 2008. The year-on-year increase reflects the expiration of personal [ph] tax holidays for some of our entities. For 2010, we expect our effective tax rate to be in the mid to low teens.

Net income for Q4 was RMB428 million, a 48% increase from the corresponding period in 2008. Basic and diluted EPS for the fourth quarter of '09 amounted to RMB12.33 and RMB12.27 respectively. Net income for the full fiscal year increased by 42%. Net income excluding share based compensation, a non-GAAP measure, for Q4 was RMB447 million, a 44% increase year-over-year. Basic and diluted EPS excluding share-based compensation expenses, both non-GAAP measures, were RMB12.87 and RMB12.80 respectively.

As of December 31, 2009, the company had cash, cash equivalents and short-term investments of RMB4.6 billion. Net operating cash flow and capital expenditure for the fourth quarter of '09 were RMB779 million and RMB146 million respectively. Full-year net operating cash flow and capital expenditures were RMB2.3 billion and RMB399 million respectively. This includes both CapEx on equipment and Baidu Campus. We will continue to invest in our server networks and expect CapEx in 2010 to be no less than the level in 2009.

In 2009, we spent $23.8 million on Baidu Japan operation versus guidance of $25 million to $30 million. For 2010, we plan to invest approximately $30 million. As you know, the quarterly expense trend for our spending on Baidu Japan has largely been established and we believe we have continuously managed this investment in a disciplined fashion. In addition, given the fact that our base continues to grow rendering the Baidu Japan expense increasingly immaterial, going forward we will not break out the quarterly expense incurred for Baidu Japan. Instead we will update only on a yearly basis, say for instance where there are material changes.

Also, given our plan to build the new online video channel, our agreement which UiTV which was announced in September 2008 has been canceled.

Now, let me provide you our top line guidance for the first quarter 2010. We currently expect total revenue for the first quarter of 2010 to be between RMB1.2 billion and RMB1.235 billion, which could represent a 48% to 52% year-over-year increase. I do wish to emphasize that this forecast reflects Baidu's current and preliminary view, which is subject to change.

I will now open the call to questions. Operator, please go ahead.

Question-and-Answer-Session

Operator

(Operator instructions) Our first question comes from the line of Dick Wei with JP Morgan; go ahead.

Dick Wei – JP Morgan

Hi, good morning. Congrats on a very good quarter. I hope that Robin can give some color in Baidu e-commerce strategy. Since the company has different platforms, (inaudible) Rakuten and Aladdin to help merchants to make their site more searchable, I wonder it is more like a transition phase; that's why you have different strategy? If you can give us what we can expect over the next few quarters, that will be very helpful. Thanks.

Robin Li

Hi, Dick; this is Robin. As I said during the prepared remarks, we believe that search engines are the biggest beneficiaries of e-commerce activities. That's way Baidu has been working on a lot of initiatives that will cultivate and stimulate e-commerce activities in China. We started with a business unit called Youa which provides better, more detailed product information for our search engine users. That has been helpful and we observed increasing search queries from the Baidu search engine product oriented queries. So Youa is still moving into that direction; meaning we are aggregating lot of product information so that the Baidu search engine users can easily find what they are looking for.

In addition to that, the Aladdin platform allows some of the content partners or application partners to submit relevant information to our search engine without – for example, the airline tickets. We can allow some of the partners to provide a more interactive interface in our search engine, so that users can easily find what they want and e-commerce providers or players can benefit from the traffic and experience we bring to them.

But that's not all; this past quarter, we struck a deal with Rakuten as a joint venture and they have lot of experience in e-commerce in Japan and we would like them to bring their experience to China, so that more and more sellers and vendors, especially those B2C oriented providers, can learn faster and serve the Chinese consumers better. We believe that the more mature the e-commerce market is China and the better our position will be.

Dick Wei – JP Morgan

We have a follow-up regarding Rakuten, anything you can discuss about the business model in China for that?

Robin Li

Okay. Rakuten is very much like an online shopping mall. They have a platform and a lot of B2C brand sellers can be hosted on their platform. They have certain customer loyalty programs. They run training courses, so that sellers can learn how to sell their products online and I believe that they will just copy the Japan model to China which we think China needs.

Dick Wei – JP Morgan

Great. Thank you very much, Robin.

Robin Li

Thanks.

Operator

Our next question comes from the line of James Mitchell with Goldman Sachs. Go ahead.

James Mitchell – Goldman Sachs

Great. Thank you for taking my question this morning. Could you talk a little bit about your guidance for revenue to decline by low single digits sequentially in what's seasonally a weak quarter, specifically does the Phoenix Nest transition help or hurt your revenue in the first quarter versus what your revenue would otherwise be? And are you seeing any revenue benefit in the first quarter from your major competitors' announcements may change status in China?

Haoyu Shen

Hi James; this is Haoyu. As we said, Q4 – when we provided guidance for Q4, we said that Q4 performance would be naturally impacted by Phoenix Nest. It was that just the impact of Phoenix Nest is just less than we expected because Phoenix Nest performed better than expected. As far as Q1, because we did a switch in December 1, so it is really very hard to quantify how much, if any, Phoenix Nest transition is still impacting the numbers we are giving today for Q1. We are really – the guidance we are giving today is really based on what we have seen so far since January 1 till today and also the historical trends we are seeing in Q1. This year's Chinese holiday is very late compared with some previous years. So all these factors are in these numbers.

So again, it is – on one hand, the transition is largely behind us, as far as the number of customers moved and the ARPU trends we are seeing. But, on the other hand, I think for some customers, the learning curve is still steep. And then on the other hand, we are probably going to see some benefit of Phoenix Nest money-raising potential to materialize during the latter part of this quarter. So a lot of things going on. There is no way for us to quantify the impact of the move for Q1 numbers.

As far as whether we have factored any impact from some potential competitor's moves, no. We are not. We are really based on what we are seeing on our numbers so far.

James Mitchell – Goldman Sachs

Thank you.

Operator

(Operator instructions) Our next question comes from the line of Ming Zhao with SIG. Go ahead.

Ming Zhao – SIG

Thank you for taking my questions. Good quarter. I have a question on the selling and marketing expense, which has been up significantly versus the previous quarter. I just want to know what has caused that. Is there anything you've done particularly to promote the Phoenix Nest system? Is that going to be last into the future quarters?

Jennifer Li

Hi, Ming. The Q4 SG&A expenses, I would attribute to two main things happening there. One is we did have a Baidu Campus begin [ph] and we celebrated (inaudible) and kicked off Baidu's tenth year anniversary celebration. So there were marketing events and branding events happened in Q4. That's one thing. The other thing is you will recall that in Q3, we increased our sales marketing – sales headcounts in Q3 and therefore Q4, we will have the full quarter's impact having that headcount increase and we continue to add headcounts on the sales side. So those are the two main drivers that drove the Q4 marketing expenses. There was nothing in particular related to Phoenix Nest in terms of promotional expenses; so nothing in that nature that was in Q4.

Ming Zhao – SIG

Okay. Just to follow up on that how many sales people do you have right now, and what's the plan for 2010?

Jennifer Li

We have about 4,400 sales people at this point and going into 2010, as I mentioned in the script, we will continue to accelerate basically hiring on the sales end, the headcount. So that's the plan. If you look back into 2009, we slowed down in our sales and marketing workforce hiring in the first part of the year and as we get more and more comfortable with the transition of Phoenix Nest we started to speed up our hiring, and going into 2010 that will continue to be the plan. I do not anticipate hiring for '10 will be any less than 2009.

Ming Zhao – SIG

Thank you, very much.

Operator

Our next question comes from the line of Eddie Leung with Banc of America. Go ahead.

Eddie Leung – Banc of America

Good morning. Did you guys give us an update on Contextual shirt? Essentially, any plans to grow out Phoenix Nest to Contextual shirt? Thanks.

Haoyu Shen

Hi, yes we had – before Phoenix Nest, we had our old Contextual product and because of the move our Contextual product has also moved to a new platform. So it is a traditionally if you saw, it was a product that we didn't really put out as much resources behind it. It will be going forward, this year, next year it will be one of our focus areas as far our R&D and product resources climate. So right now it is a small percentage of our revenue, but we would expect it will grow to be a more material and more meaningful part of our revenue.

Eddie Leung – Banc of America

Got that, thanks.

Operator

Our next question comes from the line of Catherine Leung with Citigroup. Go ahead.

Catherine Leung – Citigroup

Hi, good morning. My question was whether you will be able to elaborate on the monthly trend in the fourth quarter in terms of your customer add numbers and the revenue per customer, despite the transition you were still able to add about 7,000 customers sequentially. Did you see with that Phoenix Nest changed the difficult of you acquiring new customers because there are more features and algorithm is more complicated or did it really not matter because the customers were basically just learning how to use search from scratch? Similarly on the revenue perspective, do you believe that new customers spent more or less budget when they join considering the new budget management tool, but also everybody is just starting to compete improving their quality rating?

Haoyu Shen

This is Haoyu, specifically in Q4, I don't think these move trend to Phoenix Nest has impacted our customer acquisition that much because in the field we have two groups of people. One is acquisition, the other is customer service. So it's really the move really take the resource of field customer service people, not so the acquisition people. As far as ARPU, the ARPU in December for those customers who stayed with us, or in other words who moved to Phoenix Nest we're seeing very good trend of ARPU, which means after moved to Phoenix Nest, because of tools we are providing, because it's a better system, they are – on average anyway they are spending more money with us, for those who moved. Over longer term, the move to Phoenix Nest will impact the customer acquisition from a standpoint of it's a better product. It gives the customers a chance to realize the potential of pay search more fully, more effectively. So gradually I think that will work into the system to make our acquisition more effective. As far as ARPU, definitely it will be a good driver for ARPU growth going forward.

Catherine Leung – Citigroup

Thanks. I am sorry. If I can follow up, on the new customers, some of the brand new customers that you've acquired compared to the new customers who joined under the Classic system, with new customers joining under the Phoenix Nest system, did they initially put more budget? Is there any meaningful change under the old system?

Haoyu Shen

There is not enough data to (inaudible) this one.

Catherine Leung – Citigroup

Okay. Thank you.

Operator

Our next question comes from the line of Wallace Cheung with Credit Suisse. Go ahead.

Wallace Cheung – Credit Suisse

Hi, thank you for taking my questions. Just quickly, can you give us some color on your strategy on the (inaudible), how much are you spending going forward? Are you going to form a – introduce more investors into the new joint venture?

Robin Li

Okay. Cheung, this is Robin. (inaudible) to the online video thing, it's down through an independent company because we think the nature of that business is somewhat different from our core since we are looking to reaping some money from external resources to form this venture. We have in turn entered most of the initial costs while we spent buying content. The exact amount has not been finalized.

Jennifer Li

We will provide you relevant information as we get ready for it. Right now, as Robin mentioned, the deal has not been completely finalized. But we'll certainly look forward to providing you relevant information.

Operator

Our next question comes from the line of Eric Wen with Mirae Asset. Go ahead.

Eric Wen – Mirae Asset

Hi, good morning. Can you hear me?

Robin Li

Yes.

Eric Wen – Mirae Asset

Hello?

Robin Li

Yes we can.

Eric Wen – Mirae Asset

Okay. Thank you. Good morning and congratulation on the good quarter. Just if you can shed some light the traffic growth on fourth quarter. I think there is some slow down in the growth of web page search, and do you think that it's temporary or do you see some more slow down going forward in terms of web page search traffic in China? Thanks.

Robin Li

Well, I would say that the search traffic growth is also seasonal. During the first quarter, right after Chinese New Year, we see a dramatic growth in search traffic. Then for the rest of the year, the growth will be much slower. So for Q3 and Q4, we saw growth but it is much slower than the trend we saw after the Chinese New Year. It seemed like this for a couple of years. There is nothing significantly different this year or this past Q4. We do realize that sometimes as the government may run certain campaigns to clean up the content on the Internet landscape. Some of the unlicensed Web sites could be shut down here and there; we just need to bear with that. I think overall that the government understands Internet is good for the Chinese society and for Chinese economy. And our traffic should come back when things fair out.

Eric Wen – Mirae Asset

Okay. Thanks, Robin.

Operator

Our next question comes from the line of Aaron Kessler with Kaufman. Go ahead.

Aaron Kessler – Kaufman Bros.

Hi, good morning. Can you maybe just give us a little detail on which vertical did you saw SME strengthen in the quarter? And in terms of the Shanghai Expo, what are your thoughts on potential impact to the business? How do you think that would impact Baidu at all on either revenues or do you plan any marketing around that? Thank you.

Haoyu Shen

As far as SME sectors, the performance of verticals is very seasonal, travel, education both are very seasonal than the other natives [ph]. So we, in the past Q4, haven't seen any meaningful changes in that seasonality pattern. As far Shanghai Expo, a lot of brand advertisers won't give up for this event. But right now as far as the contributions of revenue, despite some brand advertisers, it's still a very small percentage of our total revenues. So the positive impact of this event on Baidu will be very limited.

Robin Li

And we have no plans for any significant marketing activities during the expo.

Aaron Kessler – Kaufman Bros.

Okay. My other question is about other income is a little higher than expected. Is this tax rebates or is it something else in the quarter?

Jennifer Li

Yes, typically in Q4; you would see that in prior years too, there will be some government subsidies, some rebates, just some government subsidies that would come in.

Aaron Kessler – Kaufman Bros.

Great. Thank you.

Operator

Our next question comes from the line of Richard Ji with Morgan Stanley. Go ahead.

Richard Ji – Morgan Stanley

Hi, Robin, Jennifer, and Haoyu, and congrats on a good quarter.

Robin Li

Thank you.

Richard Ji – Morgan Stanley

One positive development during the quarter is obviously you saw more large corporate customers and are they spending significantly more than the small, medium enterprises? Also what is roughly the revenue contribution from these large corporate? And I am also curious to find out what other categories for these large customers and should we expect – lot of them are in the budgeting process and lineup, should we expect more budget allocation for brand building and on Baidu to some extent [ph]?

Haoyu Shen

The growth of – hi, Richard, this is Haoyu – the growth of revenue on advertisers haven't gone up, not in the past quarter, not in the past year. I think in the past two years, we are seeing faster growth of spending from these big advertisers. So if I have to pick the – they've spent some money with us on displays, but mostly still on search because they come to appreciate Baidu Search either to their business, to their sales or even to their branding efforts. If I have to pick big sectors, Auto is definitely growing very fast. On ARPU basis, they definitely spend much more than the SMEs. And you are right, we are – in the beginning of the year, we are in the process of signing so-called framework agreement with these big advertisers just like the (inaudible). And we are seeing definitely good growth potential still going into this year. If we look at the average size of the agreements we are signing with them compared with last year, we are very happy about it.

Robin Li

And relatively (inaudible).

Richard Ji – Morgan Stanley

Okay, great. And a related question is regarding your Baidu Union growth, which has been growing faster than your organic paid search over the past one year or two. And given the transition of Phoenix Nest has largely been completed, should we expect the reacceleration of the organic paid listing versus your Baidu Union growth? And if so, should we expect you deploying more resource to acquire the Baidu Union members in 2010?

Haoyu Shen

Baidu Union revenue contribution has – Baidu Union has accounted for a bigger portion of our revenue, but the differential – the gross differential of organic versus Baidu Union has come down in the past few quarters and we expect that differential to further narrow going into this year. With our focus I don't think the migration to Phoenix Nest so much impacts the dynamic between organic and affiliate the revenue. But we are starting from last year and definitely going to this year, we will turn more focus on really differentiating the kind of traffic we are getting from partners, really to some of those partners who can bring us valuable and incremental traffic to us and we will see them differently as far as tax payout ratio goes. So that will be our focus this year.

Richard Ji – Morgan Stanley

Okay, great. That was very helpful. Thank you.

Operator

Our next question comes from the line of Yu Jin with CICC. Go ahead.

Yu Jin – CICC

Great. Thank you for taking my question. I want congratulate you on a strong quarter and I think an even stronger guidance for the first quarter. I have two questions related to Baidu Union. First one is in the past several months, (inaudible) Chinese government regulators and (inaudible) are taking more strict regulations over the website and the monies [ph], small to medium websites were strictly examined or even shutdown. So did you see any impact or do you expect an impact on your Union (inaudible) Baidu partner with many small and medium website?

And second question is also related to the Baidu Union business, I found that in the past several years actually we have seen that the company (inaudible) higher TAC ratio in the first quarter. So my question is, is it mainly because in that quarter we will see more contribution from the Union business? Is that because in this quarter, we shared more higher resource with the partners? So, like we may (inaudible) some good partners with owners? So that's my question. Thank you.

Haoyu Shen

As far the clean up impact on our Union business, I look at it and that business numbers; there is no meaningful impact on our total numbers in the past quarter. As far the TAC ratio tends to be higher in the first quarter, a big part of it is probably coincidence because from quarter to quarter – some quarters, we add some new partners or big partners. So from quarter to quarter, you see the fluctuations. The only factor that might be driving this, but probably not a big part, is in Q1 the contextual business tends to be less impacted by seasonality than the search business. And we do have a higher payout ratio on the contextual side than the video search side. So that could be a reason, but I don't think that's a driving factor; to most part, it's probably a coincidence.

Yu Jin – CICC

Okay, thank you.

Operator

Our next question comes from the line of Elinor Leung with CLSA. Go ahead.

Elinor Leung – CLSA

Hi thank you for taking my question and my question is regarding Google's potential exit from China. Have you seen any changes in the advertising market because of their announcement and also in your first Q guidance is there any revenue benefit from their exit you have seen already?

Robin Li

Like we mentioned before, we have not factored in any potential change – material change in the competitive landscape. But what we have seen in the market is that our customers, our partners' confidence level on Baidu is certainly higher, and we think we would benefit from that.

Elinor Leung – CLSA

Okay, thanks.

Operator

Our next question comes from the line of Jin Yoon with Nomura. Go ahead.

Jin Yoon – Nomura

Hi good morning everyone. Just a quick question regarding the ARPU side of Phoenix Nest; I know that when you talked about your Classic Edition in the past that I guess revenue per customer is pretty well distributed where it's not the 80/20 rule, where 80% of revenue comes from 20% of customers, because it is even more evenly skewed, can we expect the same think from Phoenix Nest going forward, or can you give some direction in terms of ARPU per customer in terms of the skewness? I will stop right there. Thanks, guys.

Haoyu Shen

As I said we are seeing good trends of ARPU for those in December till today for those who moved to Phoenix Nest. And I am trying to think whether Phoenix Nest structurally will impact the distribution or the skewness of ARPU, I don't think there is any reason. I think it will continue to be an 80/20 situation.

Jin Yoon – Nomura

It will be 80/20 or it won't be?

Haoyu Shen

It will be, positive.

Jin Yoon – Nomura

Okay, so are you saying – I am sorry, I must have misunderstood. So, it will be more of an 80/20 rule or –?

Haoyu Shen

I think of it being an 80/20 situation.

Jin Yoon – Nomura

Okay. All right, thanks guys.

Operator

Our next question comes from the line of Catherine Leung with Citigroup. Go ahead.

Catherine Leung – Citigroup

Hi, I was wondering if I could ask what would be the potential financial impact from Rakuten in the first half of this year. And also is there any expected – should we factor in any increased marketing spend related to the CCTV Spring Gala this year again? Thanks.

Jennifer Li

In our announcement, we mentioned the platform itself will be officially launched in the second half of the year. I do not anticipate any material expense related to the venture in the first half of the year. For the whole year, Rakuten – this is a JV and Baidu does not hold the controlling interest. So from an accounting and P&L standpoint, I will more likely account that on the equity accounting basis and the overall impact on the Baidu platform from a P&L standpoint this year will be small; it will not be material.

Robin Li

And we have no plans to spend significant money to advertise for the Spring Festival Gala this year.

Catherine Leung – Citigroup

Thank you.

Operator

Our next question comes from the line of Vivian Li with Piper Jaffray. Go ahead.

Vivian Li – Piper Jaffray

Hi, if you look at the driver of your revenue growth going forward, do you expect it to be the growth in number of customers or the increasing ARPU? There is still a large market out there with the 40 million SMEs in China. Can you give us some color on how you anticipate new customer acquisition will be in the next couple of years? Do you continue to expect single-digit sequential growth or will it grow at a faster rate? Thank you.

Robin Li

Well, this is Robin. I think both metrics should grow as Phoenix Nest has had a solid foundation for the search platform; we expect ARPU to grow. On the other hand, because the transition is over, we are going to invest in the sales force to acquire new customers more aggressively. I think it is really up to our execution. On both sides, there is lots of room for growth.

Vivian Li – Piper Jaffray

Okay, thank you.

Operator

Our next question comes from the line of Stephen Ju with RBC Capital. Go ahead.

Stephen Ju – RBC Capital

Good morning, everybody. So there have been reports in the media saying that Baidu is set to open a new South China headquarters in Shenzhen. How much do you think that will cost? And regarding the online video initiative, the ownership structure for the company is not that clear to me. So I am wondering if this will be consolidated or deconsolidated from the Baidu P&L. Thank you.

Jennifer Li

On the South China Baidu headquarter, I would think that as part of the overall business that we come back in the country. You do know that we do have footprint in the major cities like Beijing, Shanghai, and Guangdong provinces; and so you know, we have established a presence in Guangdong already, and I would say the South China headquarter is more an effort to consolidate furthermore and intensify our focus in that region. I would not carve out this initiative as a separate initiative away from our main business. So, this is part of the overall picture.

In terms of the online media, as I said, the deal has not been completely finalized. So we will provide the relevant information as it becomes available and we will certainly do that.

Stephen Ju – RBC Capital

Okay, thank you.

Operator

Our next question comes from the line of Wallace Cheung with Credit Suisse. Go ahead.

Wallace Cheung – Credit Suisse

Hi, can you give us an update about the top five customer sectors? Thank you.

Robin Li

Sorry, we didn’t hear you.

Wallace Cheung – Credit Suisse

I am sorry about that. Can you give us an update about the top-five customer sectors – industry groups?

Jennifer Li

Top-five customer sectors? I think Haoyu mentioned that earlier. There will always be quarter-over-quarter some seasonal nature of the sector contributions. The top sector continues to be I guess what everybody is familiar with, namely healthcare, medical equipment, agitation, travel and franchising. And one of the sectors that we do see are picking some traction is business service and this is more like recruiting, translation. So those are namely the top sectors.

Wallace Cheung – Credit Suisse

Thank you.

Operator

Our next question comes from the line of Jake Li with Guotai Junan. Go ahead.

Jake Li – Guotai Junan

Could you give us some comments about online game strategy? I know there is online game website. Particularly any explanation about the business model and do we have any plans to build out a research team or operation team? Thank you.

Haoyu Shen

Hi, this is Haoyu. We have been co-operating some online games and web-based games for a few quarters now and we are starting from this year, we are just putting more resources behind it. We're now going to have our own R&D staff. We are going – our focus is on web games, license some of the good web games to operate and we will share revenue with the game owners.

So we don't have to develop an R&D capability for the game sector. But in addition to that, I think we are a big beneficiary of the gaming industry because quite a significant amount of money have been spent on the Baidu Paid Search platform from the game operators.

Jake Li – Guotai Junan

Okay. Currently, do you have any impact on the top line and over cost? Could you give me some color about this? I mean, currently, do you have any contribution or any cost for this?

Haoyu Shen

It is still a very small revenue contribution, first of all, though we have pretty good – high expectation for this business. For us, cost, it is really the revenue-sharing model. So we don't really incur much cost on it. It is really the people we hire to operate these games.

Jake Li – Guotai Junan

Okay, thank you.

Operator

Our next question comes from the line of Eric Wen with Mirae Asset. Go ahead.

Eric Wen – Mirae Asset

Thank you very much for taking my question; appreciate it. I have a question regarding online payment and e-currency. I know this has been a hot growth area, especially in the B2C sector and what puzzles me is that Baidu has not made too much strategic inroad into this sector. My question is, do you think online payment, third-party payment, electronic currency is strategically important to Baidu or Baidu actually stays in the B2B area, (inaudible) there will be big enough for Baidu’s future growth. How do you view this issue of online payment in the overall strategic map of Baidu? Thanks.

Robin Li

Eric, as I mentioned during the past conference calls, we believe that payment is no longer a huge obstacle for Chinese e-commerce activities. There are quite a number of online payment systems. The users and consumers now do not have any problem to use those methods to pay online. Having said that, Baidu does have our own payment system called Baidu Pay; it has been growing nicely.

But, our overall strategy is that we would like to cultivate all kinds of e-commerce activities, and every sector, every part of the value channel that e-commerce growth should help us. So we would like to see more transactions done online; we would like to see more B2C e-commerce activities happen. And even today, I think Baidu already draws a lot of revenue from B2C e-commerce players because they just cannot find any other market platform that can drive enough amount of traffic to them and build an (inaudible) brand for them as an online retailer.

So we would be happy to see the payment system to grow and then mature, and we will certainly benefit from that. Our addressable market is currently not limited to the B2B sectors. B2C actually probably already represent a larger percentage of our revenue.

Operator

Ladies and gentlemen, we are now approaching the end of the conference call. I would like to turn the call back over to Baidu’s Chief Executive Officer, Robin Li, for his closing remarks.

Robin Li

Well, thank you again for joining us today. Please do not hesitate to contact us if you have any further questions.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Baidu, Inc. Q4 2009 Earnings Call Transcript
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