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Investment thesis
Baidu’s (BIDU) Q1’21 results further showcased its impressive execution ability to continue to drive its non-search/non-advertising business. Regardless of this, Baidu is only trading at the same level as Sogou (SOGO). This implies that the market is currently not assigning any value to Baidu’s non-search business at all, which has had very robust growth, esp. in Q1.
Valuation upside should arise from both the recognition of Baidu’s non-search business by the market and the expectation that its non-search business will continue to grow in the future.
Q1 results – where it all made sense
For a long time in the past, investors might feel that Baidu has been running around, trying to work on all sorts of “buzzwords” out there without much strategic focus.
Many became skeptical and started to question “what’s next” after its search business. Looking at its Q1 results, for the first time, I felt that it all made sense with all the puzzles starting to piece together.
Intelligent driving:
When Baidu first started working on autonomous driving eight years ago, people thought it’s cool because Google was doing that, too. When it announced its plan to start manufacturing electric cars at the end of last year, people again thought it was just trying to tap into the next “hot stuff” by following the other EV makers.
By now, we understand that Baidu or Apollo is not just trying to build autonomous cars or electric cars. It’s building the whole ecosystem, or the whole infrastructure of a smart city, where cars (autonomous or electric) are connected, roads are connected, and cars and roads are interconnected (via V2X). This is exactly happening in Guangzhou, a major city in southern China where Baidu is testing this vision.
Apollo is not only providing hardware but also software and services. Like the co-founder, Robin Li, said at the earnings call, nobody on this planet has a more comprehensive solution than Baidu when it comes to EV. And that advantage will only add up.
Once the infrastructure is ready, the means of monetization for this can be numerous. For example, its fully autonomous ride-hailing service (first in China), Apollo Go, is now open to the public at the Shougang Park (a 2022 Winter Olympics site) at a fixed fare. It also began to charge for robotaxi ride-hailing in another Chinese city, based on the distance traveled. The means of monetization for this will only further increase in the future.
AI cloud:
AI cloud’s revenue had a strong growth of 55% year-over-year in Q1’21. Its growth rate is expected to further accelerate in the future, especially in sectors such as Internet media, financial services, and other high-tech sectors.
Part of the reason for the AI cloud’s strong growth is also thanks to its intelligent driving initiatives. As different Chinese cities task Baidu/Apollo with building the intelligent driving and smart city ecosystems, they will need cloud solutions as well to support such operations. Baidu’s AI cloud solution, therefore, becomes the natural fit for that.
Mobile ecosystem:
Traditionally, Baidu’s mobile ecosystem has relied on online advertising for monetization. But with its numerous users (and hence data), the company well understands that there’s a lot more it can do to monetize from such traffic, by leveraging its AI capability, than just online advertising.
As such, Baidu has been endeavoring to enrich its ecosystem by letting its users enjoy all kinds of other services, e.g., having access to premium content, e-commerce transactions, playing mobile games, etc.
Its mobile app MAUs has reached 558 million in Q1’21 (vs. 500 million at the end of 2019). And that’s exactly why Baidu has been calling itself a leading AI company with a strong Internet foundation.
Thanks to all these initiatives and investments Baidu made almost a decade ago when the market couldn’t possibly grasp the meaning behind, now the company’s non-advertising revenue (within Baidu Core) in Q1 grew by 70% year-over-year. Management even expects its non-advertising revenue to likely exceed its advertising revenue (within Baidu Core) in the next three years.
That will be a very different Baidu from the one we see today.
Baidu trading at the same level as Sogou
Regardless of such strong results and fundamental development, Baidu’s P/S multiple has been trading at the same level as the smaller, pure-play search peer, Sogou (SOGO).
Baidu's and Sogou’s trading P/S:
Source: Capital IQ
To me, this clearly doesn’t make sense since, by now, at least we all can agree that Baidu is much more than just a search engine.
Baidu's revenue mix:
Source: company financial reports
As mentioned before, we can resort to a more “simplified” SOTP by gauging Baidu’s revenue mix in order to understand its (under)valuation.
Source: company financial reports; Capital IQ
By applying Sogou’s P/S multiple to value Baidu’s search business, we can derive the implied multiple of its non-search business (0.9x) after further accounting for its net cash position.
As its non-search businesses include high-flying businesses such as cloud, autonomous driving, EV, AI, etc., a P/S multiple of 0.9x just seems awfully low.
But, what should be the right multiple then?
The dislocation opportunity is too significant to ignore
Frankly, there will possibly be an upside regardless of the multiple you would apply to Baidu’s non-search business because its current valuation level is too low.
The following table presents three types of company sets Baidu’s non-search business can be benchmarked to, in my opinion – China Tech, US Tech, and EV makers.
Source: Capital IQ
The sensitivity table below shows the upside arising from each company set used as compared to Baidu’s current valuation level:
There is even an upside of 20% if Baidu’s non-search business is benchmarked to Sogou’s current multiple of 4.0x.
The implosion of Archegos Capital has clearly attributed to Baidu’s current undervaluation, which doesn’t’ have much to do with its fundamentals. With the potential upside shown above and its strong Q1 results, I won’t be surprised to see more and more institutional investors come in to take advantage of this dislocation opportunity, such as Soros Fund and York Capital.
Risks/Concerns
One concern investors might have is the management’s execution ability to continue to drive the development of the company’s non-search business.
Looking at the consistent growth trend of the non-search business over the past few years, especially in Q1, I do think the risk is limited or contained. Besides, the (under)valuation of Baidu showcased above is based on the company’s LTM revenue. Hence, the 20% - 50% upside is based on what has already been reflected in the financials.
Another risk factor is the hotly debated Holding Foreign Companies Accountable Act in the US.
In my opinion, if the worst-case scenario really materializes where Baidu is delisted (which is unlikely), its US-listed ADR would either move to the OTC market or be “redeemed” with its HK-listed shares. Either way, the value of a company will not simply drop to zero when its fundamentals are actually intact.
Final words
The upside or return from Baidu at this point is tremendous no matter how you dissect its valuation, to be honest. Is there a risk? Yes, just like any other investment. But the valuation upside by far outweighs its potential risk at this point, in my opinion.
With such promising Q1 results and progress on its transformation, the company is honestly dirt cheap right now, especially given the growth potential it could have in the next 3 – 5 years.