Baidu (NASDAQ:BIDU) has had a torrid time of late. The share price has collapsed over the last 12 months, from a high of $234/share to just over $100/share, due to a myriad of concerns. Baidu remains a solid long-term play, and while there are risks, is well-positioned to provide solid investor returns.
There is very good reason why Baidu is variously described as the Google (GOOGL) of China. It has built has a robust network effect business around search, having been in the search business for the better part of 2 decades. With Google having effectively exited the Chinese search market in 2010, this has largely been Baidu’s for the taking, with the company now having search-based market share of close to 75% in the Chinese market, which has generally been fairly consistent.
Search Engine Market Share in China
Source: MarketingToChina.com
Baidu has more the 400 million mobile search users in its ecosystem, and benefits from a network effect and a rich data stream that comes from the hundreds of millions of search queries that these users do regularly which helps to improve the prioritization of search results, which Baidu can in turn leverage to provide a more personalized, relevant experience to users.
It would be highly unlikely, if at all possible, for any new provider to the market to be able to replicate the years of search data, database of users and merchant aggregation that Baidu has been able to amass over the years. Even if all this could be done in a reasonable period of time, the development and refinement of search algorithms to collate all of these results is no mean feat. The one caveat to this would be the re-entry into the Chinese market in a more meaningful way of an experienced player like Google (GOOGL). This has been the subject of much speculation in recent months, but no firm commitment by Google has been made. Even here, customization of Google’s algorithms would be needed to support local preferences and provide cultural context to results, no trivial matter.
Baidu’s moat has lost a little bit of luster in result years as a result of the healthcare scandal that it was hit with in 2016. Political backlash over the death of a student who supposedly "followed a cure" by going through one of Baidu's advertising links has resulted in a directive for the company to overhaul how it prioritizes advertising on its site, with advertiser credibility now a major weighting factor.
The company’s revenues from healthcare have sustained a near-term hit as so-called "spurious advertisers" in the healthcare market saw their advertising links weighted significantly downward, or even pulled completely by Baidu, and as Baidu migrates these providers to a healthcare portal more tightly managed and vetted by it, which will ultimately be important to help restore faith and credibility in the company.
One of the longer-term dangers for Baidu is the impact that Tencent’s (OTCPK:TCEHY) WeChat may play in diverting search based traffic to app-based traffic via the range of mini programs that Tencent has carefully curated. It’s a unique cultural phenomenon of the Chinese market that WeChat has so effectively become a lifestyle concierge for so many Chinese and is able to help them successfully manage so many aspects of daily life. WeChat’s success is unmistakable here. With over 1 billion daily active users, WeChat users tend to log into the application 10 times a day. WeChat accounts for a staggering 34% of all mobile data traffic in China, with 17 million official accounts, and is the 5th most used application in the world. One-third of users spend over 4 hours a day on the platform. While application-based functionality can never totally overhaul search, WeChat may slowly be siphoning off many of the most profitable search categories for Baidu in shopping, commerce and travel. Baidu has responded to Tencent’s challenge in kind by developing its own set of mini apps within the Baidu mobile app, but it still doesn’t have the user base (near 200 million) or richness of application ecosystem that Tencent does. Baidu’s search volume continues to grow, and the near-term threat is likely limited. However, the company’s long-term competitive response will be important.
Perhaps motivated by the Tencent threat, Baidu has embarked on an aggressive investment program to improve search and complement its effectiveness to the user by investing in a range of AI capabilities. This aggressive investment program has had the effect of depressing near-term margins and profitability, but should pay more meaningful dividends longer term. Developing an AI-based platform has been the most notable of these initiatives, with Baidu having developed a voice assistant platform DuerOS. as well as an autonomous driving platform and AI cloud services. Anything that can enhance the ease of search and search effectiveness will ultimately be beneficial to the company’s long-term moat.
Baidu’s net margins have dramatically fallen over the last 18 months as a result of the aggressive investment program that it has embarked on. The combination of investments in AI-based technologies and content investments for its video platform have served to depress margins and sent Baidu into an operating loss for the first quarter in 2019. The company managed to turn this around for Q2, and it delivered positive operating margins in the quarter.
Baidu reported a revenue picture which, while modest, managed to beat expectations with growth of 1.1% year over year. The near-term picture for the company continues to be relatively dour, with it only forecasting revenue growth of -1% to 5% for Q3, with subdued near-term growth attributed by management to a slower macro environment and shifts in the administration of healthcare-related offerings to a centralized portal.
Over the medium term, Baidu’s investment in AI monetization should pay handsome dividends as far as providing a more convenient way for users to access the company’s search algorithm and stem some of the bleed away to alternative interfaces to access information, such as WeChat. AI-related investments should also start to fall away over the next 12-18 months as Baidu starts to commercialize some of this development. This should translate into a material uplift in earnings growth over the medium term, with analysts expecting Baidu’s medium-term earnings profile to average just under 10% growth over the next 5 years.
While there are certainly threats on the horizon for the company from Tencent’s continued social media dominance and questions around whether AI-related investments can enhance user experience, Baidu is positioning itself well for continued growth, and with a share price that is the lowest that it's been for almost 6 years, provides a reasonable value proposition for investors that can look past the likely near-term turbulence.
This article was written by
I am an investor who is focused on disruptive businesses that are transforming industries lead by visionary leaders with substantial skin in the game. I have spent nearly 20 years in a formal capacity in various investment banking and corporate advisory roles, having attained my MBA with a concentration in finance. This led me toward a path in Venture Capital and working with entrepreneurs building new technology businesses, and I have had the opportunity to not only invest in a number of amazing privately held businesses, but also play a meaningful role in growing several of these early stage enterprises as well. I am now focused on applying my lens of private market disruption and leveraging secular tail winds to the public markets. This was a journey which I started with my public Project $1M portfolio series and which I have deepened with my marketplace service, Sustainable Growth
Disclosure: I am/we are long BIDU, TCEHY, GOOG. 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.