Baidu: Time To Punch Out

| About: Baidu, Inc. (BIDU)

Summary

BIDU reported a largely in-line quarter with guidance below consensus on regulatory oversight.

Core search appears to face maturity with search and map MAUs showing further deceleration while O2O remains the growth engine.

Weaker outlook on regulatory concerns could potentially mask BIDU’s deteriorating fundamentals of a maturing search market and inferior ecosystem. Remain bearish. Prefer BABA over BIDU.

Baidu (NASDAQ:BIDU) reported largely an in-line revenue, a slight beat on EPS and an in-line guidance. There were no surprises on the Q2 headline numbers but there were certainly evidence of a maturing search business and stagnating growth profile. More important, the bigger concern was management commentaries on BIDU's outlook in light of the increased regulatory oversight which could result in further pressure on the stock price in the coming quarters. In addition, the weak outlook could also potentially suggest faster than expected deceleration in the core business and that the existing growth segment such as O2O is still too small to offset any core weakness.

In my view, the issue with BIDU lies in its lack of innovation given that majority of its business model mirrors that of Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Facebook (NASDAQ:FB). While BIDU will no doubt remain the dominant leader in search, it is difficult to see how BIDU is leveraging search to build its ecosystem. The acquisition of Nuomi and the development of its map services give BIDU exposure to the fast growing O2O space, but this segment continues to face competition from Tencent (OTCPK:TCEHY) and Alibaba (NYSE:BABA) that have a much superior ecosystem. The entry into driverless cars is certainly the right direction but the progress remains slow relative to GOOG so it may not have much material impact on its revenue profile. I have been cautious on BIDU's outlook since day one and will remain so. BIDU stays last in my Chinese internet pecking order, behind my top pick BABA and second place Tencent.

Revenue of $2.75b was in-line with $2.72b consensus estimate while EPS of $1.22 beat by $0.04. As I mentioned earlier, there were no surprises to the headline numbers after the company cut its Q2 expectations but the guidance of $2.714b-$2.796b is well below estimate of $2.98b due to China's tighter guidelines on online ads which will continue to keep revenue suppressed for several more quarters. Mobile search MAU of 667m was a +6% y/y growth and suggested growing maturity of its core search business and this is starting to impact BIDU's other ecosystem components such as its map asset that saw MAU growth of only +13% to 343m compared with +43% in 4Q15 and +19% last quarter. Given that much of BIDU's ecosystem is tied to search, search's decline will ultimately impact BIDU's other services such as map, media, online travel and so forth.

O2O remains the bright spot with GMV growth of +166% to $2.7b and wallet active accounts of 88m compared with 65m in the last quarter. I suspect that a considerable amount of advertising and promotion were spent in Nuomi to drive that wallet adoption due to the maturing map search MAU base and I wonder how sustainable this trend may be. All things considered, I continue to see higher competitive intensity from WeChat and Alipay as rivals ramp up on their respective O2O platforms.

Finally, while I am positive on BIDU's initiative of diversifying away from search, I am concerned about the pace of progress may not be materially accretive to drive search growth. Regulatory oversight certainly has an impact on BIDU but investors should ask themselves whether BIDU's lower outlook is reflective of the bigger concerns on its lack of innovation and over-reliance on search. That said, I would recommend investors to switch out of BIDU and put their money in BABA in that ecommerce remains the retail growth engine in China, BABA remains the dominant player in China and global ecommerce and BABA's ecosystem is vastly superior than that of its rivals.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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