Baidu: Recent Volatility Unlikely Caused By Fundamentals Could Be Another Good Entry Window

Summary

• Archegos Capital’s liquidation sale last Fri caused sharp drop in Baidu’s share price.
• Concerns arising from data collection and delisting regulations will unlikely impact its fundamentals in the long run.
• The key is to ask if there’s an investment case. If there is, market volatility actually presents a good entry window.

Photo: IC Photo

Dramatic price movement last Fri caused by Archegos Capital’s liquidation sale instead of fundamentals

The share price movement of Baidu (BIDU) last Friday is nothing but dramatic.

With the overhang of a large hedge fund/family office (later confirmed as Archegos Captial, the family office run by Bill Hwang) being forced to liquidate its stakes, Baidu’s share price dropped by almost 15% once the market opened last Friday.

However, what’s even more dramatic is its strong rebound of almost 20% from the bottom as value investors rushed in to take advantage of its dirt-cheap valuation.

It was further reported that both Snow Lake Capital (the hedge fund that was rumored to first publish and share the short-selling report on Luckin Coffee) and ARK were among the funds which scooped up Baidu’s shares at the bottom.

Major market concerns will unlikely have material impact on the fundamentals in the long run

In addition to the broader pull-back of the overall tech sector, Baidu’s share price has been tamed by two major market concerns:

Delisting concern: although most of the media coverage has made it seem like this is going to happen tomorrow, it’s actually going to take quite some time. A Chinese company will only be kicked out if it fails to comply with the new regulation for three consecutive years.

A lot of things can happen in three years. For one, many investors probably won’t even hold a stock for more than three years, to begin with. The risk is definitely there (just like any other risk), but how imminent is it? Will the company’s share price really drop to zero, like many feared, if it gets delisted?

First off, the company is now trading in Hong Kong with a fair market price. It would be difficult to foresee a dislocation scenario where it will be trading at a certain price level in Hong Kong while its ADR in the US drops to zero. Secondly, even if the company really gets delisted, I believe it would either choose to redeem the ADRs in the US or swap the ADRs with the Hong Kong-listed shares. In any case, the value won’t simply be zero when the company’s operations and fundamentals are intact.

Chinese government establishing JV with tech giants to regulate data collection: I think this will impact platform companies more, such as Tencent (OTCPK:TCEHY) and Alibaba (BABA), and less so on Baidu in the long run, since it’s shifting its focus away from search.

Given that Baidu is one of the tech giants in China, it will definitely be impacted by this potential regulation. But again, we need to ask ourselves how material it can be. After all, it’s in the government’s interest to promote home-grown technologies (amid tensions with the US), especially the ones that are being focused on by Baidu (i.e., AI and intelligent driving).

Fundamentals remain intact and unchanged

Baidu’s share price has experienced a significant correction since its peak in mid. February. Its Friday close represents a 40% drop since then.

In my opinion, at the company level, nothing has really changed fundamentally (and hence the investment thesis). After all, a company’s fundamentals don’t change (for better or worse) overnight, or in a matter of weeks.

As a long-term “fundamentalist” investor, the correction, to me, is mere background noise or even an opportunity to buy more at an attractive valuation level, provided that you truly believe in the investment thesis from the get-go.

“Be fearful when others are greedy, and be greedy when others are fearful”

It does seem a bit cliché to quote this. But then it’s one thing to know the meaning of a famous quote, it’s another to act accordingly.

And last Friday was exactly the moment that tested one’s investment philosophy or approach. It’s easy to claim to be a fundamentalist, it’s another to act as one.

At Baidu’s current market capitalization of $74 billion, it seriously represents deep, deep value, for a tech giant that’s spearheading its AI and intelligent driving initiatives.

I have detailed my thinking in my previous article (Baidu: Recent Share Price Drop Is An Opportune Entry Window), where even at a market capitalization of $86 billion a week ago (let alone its current one), the market was not assigning any value to Baidu’s high growth initiatives at all.

As cliché as it goes – any investment can be a good investment if one buys it cheap. Are we witnessing one of those opportunities?

Ongoing strategic transformation with attractive growth prospects

Amid all the market news or noise, I still think the key is to ask ourselves if we have an investment case here.

To me, Baidu’s investment thesis is its ongoing strategic transformation from a search-driven company to a tech company whose underlying value will be increasingly driven by high-growth non-search businesses, such as AI, cloud, and intelligent driving.

Given the limited segmental information the company disclosed to public investors, it’s frankly difficult for one to track the progress or the development of such transformation.

On a high-level basis, we can track its revenue mix, which shows the breakdown of online marketing and non-marketing revenue contribution over the past few years.

Baidu’s revenue mix from 2017 – 2020

Source: Baidu company disclosure

 As one can see, although the non-marketing revenue contribution was still standing only at 32% in 2020, the trend of the company’s revenue mix shifting to non-marketing is quite clear and has been going on for quite some time.

During the management call when Baidu announced its full-year results, the management did express their expectation on the non-search business to accelerate further into 2021. It will be interesting to see its Q1’21 revenue mix soon.

Final words

Baidu’s share price drop last Friday clearly didn’t have much to do with its fundamentals while current market concerns surrounding the company will also unlikely impact its fundamentals or growth in the long run. Amid all the market news or noise, what’s more important is to ask ourselves if there’s an investment case.

If there is, the price drop simply becomes white noise (or even an entry window). After all, the key to great long-term investing is 99% waiting.