Baidu Reports A Strong Quarter, Faces Headwinds

Jul.24.12 | About: Baidu, Inc. (BIDU)

Baidu has been taking a beating over the past few months, falling from $151.38 on April 13th to $104.98 on July 17th, a week before earnings. The stock is up 10% today on a strong earnings call. All signs in the macro environment pointed towards a potentially weak earnings call and guidance, but they beat expectations and gave guidance in the middle of the consensus range. The full transcript is linked here.

I was bullish on Baidu when it was ~$85 a share, which is one of my most read articles on Seeking Alpha. I've since tempered my optimism on the stock, but it still interests me as an internet giant in one of the world's most interesting markets. Let's see how they've been doing lately.

Financial Snapshot

Yesterday Baidu (NASDAQ:BIDU) reported a strong quarter. Revenues stood at $858.8 million, almost a 60% increase from Q2 2011. Operating profits were $443.1 million, a 51.5% increase from the same period in 2011. Finally, net income increased by 69.6% compared to the same period in 2011, to $436 million.

These are great numbers for a "normal" company; however, they represent some decreases compared to 2010 Baidu. Some analysts are saying that this is a death knell for the company, but at almost 40 billion in market cap, I would expect some bumps in the road. Their expenses continue to climb, but they are also expanding into the mobile and cloud spheres, where they could potentially offset those costs with future growth. The following points stuck out to me in the earnings call.

Traffic Acquisition Cost (TAC)

As expected, traffic acquisition cost continued to increase. TAC cost reductions used to be the driver of profits for Baidu, decreasing for period after period and contributing to strong earnings. Since then, it has almost flattened out, which a slight increase this quarter.

However, this quarter, the increase in TAC crossed over the increase in revenues; TAC increased by over 71% while revenues jumped by only 59.6%. Simply put, if TAC continues to continue at a higher rate than revenues, profits will come under downward pressure. TAC as a cost of revenues was $71.4 million, which represents 8.3% of total revenues compared to 7.9% in the corresponding period in 2011. For comparison, at the beginning of 2010, TAC was over 13% (although growing at a slower clip, which led to the decrease as a percentage of revenue).

Operating Expenses Continue to Climb

The operating costs for Baidu continue to climb with their revenues. Bandwidth jumped up as a percentage of revenues to 4.4%, an increase from the same period in 2011. Depreciation was 4.6% of revenues, compared with 4.2% in 2011. Both of these were reportedly due to an increase in their network infrastructure capacity. SG&A expenses stood at $92.5 million, representing an increase of 55.6% from the corresponding period in 2011, primarily due to hiring more personnel and marketing expenses. Research and development expenses were $85.9 million, an 82.7% increase from the corresponding period in 2011. This increase outpaces revenue growth, but should be taken as a positive for a technology giant. The R&D has obviously been put to work, as CEO Robin Li explains below.

Proliferation of Mobile for Baidu

Mobile is a huge opportunity for Baidu, as they can learn from the West that soon their users will live inside their mobile devices. Although not every Chinese customer will have an iPad by the end of 2015, they can certainly appreciate the proliferation of mobile technology and lifestyle in America and Europe. As a result, they've focused considerable dollars on these items. In the call, CEO Li explained that:

On the user front, mobile continues to grow very well and we are really charging ahead to build a truly frictionless experience for mobile users. Our cell phone allows users to efficiently access the underlying information, content, app and services they want through many mobile operating environment as possible.

One of our most innovative new initiatives here is our powerful new voice search experience. This is defined to enable smartphone users to search the web, activate apps and even get local information just by speaking into their phone. The accuracy of our voice search technology is unmatched and we have already rolled out some fore functions based on it. For example, if a user says I'm at the Baidu campus, the system will instantly text them on Baidu campus and provide a map of the neighborhood. If the user says, I want to call Mom, the program will instantly start the call. Users can even use voice to search native apps and of course search the web.

Voice search may not differentiate Baidu on a global scale, but it will help keep them relevant as technologies progress. The increase in their R&D shows this commitment to continued growth. Mobile seems to be responding in a big way as:

User numbers for the mobile app have more than doubled from 9 million in Q1 to 20 million by the end of June. And we are working on building PCS integration into many third-party developers' apps and our own product such as Baidu music.

Sound familiar? It seems like they are attempting to build an app ecosystem in much the same vein as Apple and Android. It will be interesting to see what sort of acceptance this gains. Also, it is worth noting that 20 million people out of 1.2 billion is not an overwhelming market share. Speaking of Apple, Li also explained that Baidu's:

personalized homepage is now completely iOS friendly and has been optimized for users on the go.

Hey, better late than never.

Head in the Clouds

In addition to mobile, cloud is another opportunity for Baidu to differentiate themselves from competitors in the area. Li spoke to their cloud advantage:

One reason that Baidu stands head and shoulders above every other company in the mobile space is unparalleled cloud computing infrastructure. Our personal cloud storage service or PCS for short which we launched last quarter is one of the pillars of this strategy. Over the last few months we have been working hard to integrate into more of our applications and services and to promote this to our users.

Our Netdisk service has installed millions of times while still in beta testing. And Baidu users can now also leverage PCS to access, via PhotoWonder images, from anywhere and any device. The ability to sync up with Baidu album through PCS is a great starting point for PhotoWonder.

The ability to combine this cloud ability with their apps and mobile integration could be a great advantage for Baidu.


Baidu is not as attractive an opportunity as it was in 2010. At that time, they were growing at an astronomical rate without any sign of slowing. Since, they've faced some macro headwinds that have slowed their roll. However, this is not Yahoo (NASDAQ:YHOO). They have a solid strategy to focus on search while expanding into mobile, cloud and location specific services. The opportunity in China is huge, and the market is far from mature. The question for investors, then, is whether you believe this opportunity is worth the price premium you have to pay for a stock like Baidu.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.