Baidu: Moving Beyond Ad Revenues

| About: Baidu, Inc. (BIDU)
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Baidu, just like Google, is over dependent on ad revenue.

A recent regulatory setback is prompting it to look elsewhere to generate revenue.

A driverless car is the key area it is focusing on.

Baidu Inc. (NASDAQ:BIDU) is a poster boy for how state protection can actually help nurture a small local business against global biggies, creating a level playing field for the locals to compete. For Baidu, this state protection came in the form of censorship. According to my book of ancient history, global companies like Google - Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) today - were required by the Chinese government to implement extensive self censorship.

If they didn't comply, it was made difficult for them to remain in China - there were even reports of government-sponsored cyber attacks on these companies. As a result of all this, Google shut shop in China in 2010, making it much easier for Baidu to dominate market space there. Baidu willingly complied with Chinese censorship laws. Google took a principled stand - but that translated into lost revenue of billions of dollars. Honesty is a sucker for punishment.

Such a thing is not possible in a country like India because people are recklessly non-compliant. The present right-wing government sometimes experiments with censoring/banning porn websites. Then a government minister gets caught watching porn on his smartphone in the parliament - there goes censorship!

That is a joke, but that also highlights an investment angle in Chinese companies. Which is this - every country tries to protect its industries to an extent, but Chinese companies complying with Chinese laws enjoy protection to such an extent that they become an extension of the government itself. Therein lies their strength, and there also lies their weakness.

While Baidu hotly disputes this, it is nevertheless true, as evinced from the pro-democracy censorship lawsuit in the US against Baidu - which Baidu won. Baidu is China-compliant.

Coming back to China, this sort of compliance is partly responsible for Baidu's 80% plus market share in that country. A great search engine geared toward local needs is the other major contributor.

Baidu today rivals Google in every space, including driverless car technology. Just like Google, the bulk of its revenues come from online marketing and advertisement. As reported in its latest earnings report:

Baidu reported total revenues of RMB18.264 billion ($2.748 billion) for the second quarter of 2016, representing a 10.2% increase from the corresponding period in 2015.

Online marketing revenues for the second quarter of 2016 were RMB16.939 billion ($2.549 billion).

That's 92% of its total revenue. That number is similar for Google, where almost 90% of over $75 billion in revenues comes from online ads. The story is the same - Google is just a great deal bigger.

One problem Baidu has faced recently is that its ads on search pages can be hardly differentiated from organic results. This has, for a long time, driven Baidu's growth, despite poor customer experience. Recently, the Chinese government passed laws against this practice, which apparently benefited ad marketing rival Alibaba (NYSE:BABA) over Baidu.

This entire incident was the result of Baidu displaying promoted ads for a hospital chain which purported to help cancer patients. A young Chinese guy saw these ads, and went to one of these hospitals, which caused his death. There was a large-scale scandal, resulting in the new search engine laws regarding relevance of ads. This single incident caused a lot of loss for Baidu's market share.

Since Baidu is so dependent on search engine ads that a single problem like this can drastically harm the company, Baidu is now actively trying to diversify itself to very unrelated segments. The driverless car program which it has begun with Nvidia (NASDAQ:NVDA) is a step in that direction.

Having tested its driverless car on Chinese roads, Baidu is now looking to test it on California roads as well. The vehicle is powered by Baidu/NVDA's cloud-to-vehicle technology. The two companies formed a partnership this year to develop this technology based on cloud-based 3D maps, which the car's intelligent sensors will use on the roads.

The two companies, one led by a Chinese, Robin Li, and the other by a Taiwan-origin Jen-Hsun Huang, have a long history of collaboration. Baidu's expertise lies in map-making and the cloud, while Nvidia is taking control of the hardware aspect of things, mainly the processor.

According to a Business Insider report, there may be 10 million self-driving cars in the market by 2020. Three major problems that self-driving vehicle technology face toward adoption - cost of components, customer wariness and regulation - are easily solvable within the Chinese business universe. China is, after all, the country of low-cost manufacturing.

The Chinese customer is perhaps more adaptive of technology that is approved by the government. As for regulation, according to a Fortune report, China may actually be way ahead of the US and Europe in terms of creating a monolithic set of standards for driverless driving. Lastly, China happens to be the largest auto market in the world.

So it will not be surprising if China becomes the first country to massively adopt self-driving technology. It will be a matter of prestige, a way to show that the C2C view - Copy to China - is not always right.

And if that happens, Baidu is positioning itself in just the right place for capturing a huge chunk of such a market. According to the company, it plans to launch its self-driven autonomously developed cars by 2018. While that may be too ambitious, it has still positioned itself well with its Nvidia partnership.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BIDU over 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.