Baidu: Cutting Forecast On Weaker Outlook

| About: Baidu, Inc. (BIDU)

Summary

BIDU reported lower guidance for Q2 due to regulatory oversight over the healthcare sector.

Expect near-term volatility of the shares as investors gauge the future impact from this ad slowdown.

Cautious on BIDU, Prefer BABA among Chinese large caps.

Baidu (NASDAQ:BIDU) cut its revenue guidance after the market close on Monday now expecting Q2 revenue to be Rmb18.1bn to Rmb18.bn vs. the prior guidance of Rmb20.1bn to $20.6bn. The lower guidance is mainly driven by the growing regulatory oversight relating to healthcare advertising in which the authorities have implemented stricter advertising regulation on the companies. Additionally, BIDU will reduce the number of sponsored link on its website to cut back on the amount of advertisement so it can improve use experience. However, I believe that the company could also be limited the amount of questionable advertisements on its sites until it has fully reviewed and vetted the quality of merchants before allowing them back on BIDU's search pages. Regardless, I believe that BIDU could face near-term volatility as investors try to determine whether the regulatory pressure could persist into year-end. I would remain cautious on the stock but recommend investors to accumulate on weakness given that this is minor issue. I see this process to be a natural evolution of China's internet company and online healthcare standard.

In the wake of a student's death after he sought medical treatment over BIDU, regulators are placing greater emphasis on BIDU's advertising practices, especially those of medical, pharma and healthcare businesses. The government is reviewing advertising guidelines for the internet companies across all geographies. This process will take time and will certainly impact BIDU's revenue outlook as advertisers from those verticals pull back on their budget. Additionally, advertisers are also adjusting their marketing practices to better comply with the regulators and this will limit the amount of money they allocate to search engines. Indeed, BIDU noted that several high quality customers have already reduced or delayed their spending to comply with the regulations. Near-term outlook is certainly not optimistic for BIDU.

Besides specific vertical clients pulling back their budget, BIDU is also limiting the amount of sponsored ads on its search pages. Although BIDU cited the need to drive better user experience, I suspect the real rationale is that BIDU may be conducting their internal audit process on the advertisers to ensure a better quality client base and I cannot argue against that.

In conclusion, I remain cautious on BIDU shares in the near-term due to the uncertainty involved with the regulators. For investors who are pulling money out of BIDU, my preferred pick is Alibaba (NYSE:BABA).

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