Baidu Stock Review – Why It Is Undervalued

Baidu stock price has climbed more than 200% to over $300 since the market crash in 2020. But since then it has corrected to the $200 range recently. Does it imply an opportunity to investors? Let’s check it out.

Baidu Stock Business Overview

For the sake of everyone, let’s quickly run through Baidu’s businesses.

Baidu Stock Annual Report FY2020 / Revenue By Segments

Source: Baidu Annual Report FY2020 / Revenue By Segments

Understand that the company’s core business is still fundamentally a Search Engine. And it is increasingly trying to diversify to other products and services. Hence, the other key revenue arm is from its content streaming services known as iQIYI. This is also seen as the Netflix of China, streaming popular TV and movies online.

Therefore, Baidu segregates its business into 2 key operating segments.

Baidu Core, which is made up of 3 subcategories: Online marketing services (mainly associated with its Search Engine), Cloud Services and Others.

Source: Statista / Market share of search engines in China as of November 2020, based on pageview

Its Search Engine commands a dominant share of more than 70% in China’s search engines market.

The second operating segment is iQIYI, which is generating income mainly from membership subscriptions and advertising services.

2018 – 2020 Baidu Stock Performance

Understand that its share price has lost momentum since mid 2018. It lost around 50% of its value even before the Coronavirus market crash in 2020.

I think we can attribute this to 2 key causes behind Baidu’s share performance between 2018 to 2020.

First, at the micro-level, the company seemed unable to monetize from its user base sufficiently. Also, they seem not able to diversify to avoid reliance on its online marketing services. This is important as it has been contributing about 70% to the company’s revenue.

Secondly, it pertains to the macro-level in terms of the tensions between the United States and China, as well as the regulatory risks in China itself. The latter can be seen from recent fines related to antitrust issues that the authority has become more focused on.

So these 2 items are why the market is penalizing its share price prior to the Covid-19 outbreak.

Baidu Stock Recent Performance Review

Now, coming back to recent performance, we see a mix of positive and negative results.

Declining Advertising Revenue

Let’s talk about the negatives first.

Baidu Stock Annual Report FY2020 / Revenue By Segments

Source: Baidu Annual Report FY2020 / Revenue By Segments

You can observe that apart from Baidu’s reliance on its Search Engine online marketing services, this key driver is experiencing decrease in revenue over the past few years. It fell from RMB 72.6 billion in 2018 to RMB 70.0 billion in 2019. And in 2020 itself, it dropped further to RMB 66.3 billion.

This creates worry for its shareholders. Although the company has a dominant share in the Search Engine market, its advertising revenue is still being eroded away by its Chinese peers.

Baidu Stock Annual Report Q4 2020 / Condensed Consolidated Statements of Income (Loss)

Source: Baidu Annual Report Q4 2020 / Condensed Consolidated Statements of Income (Loss)

For instance, Baidu did register a slight improvement in its online marketing services revenue of 2.5% in the latest Q4 2020. However, its competitors like Tencent and BiliBili saw their ads revenue improved by 16% and 126% respectively year-over-year in the latest quarter.

This seems to imply that rather than macro headwinds and effect of the pandemic on companies’ budget cuts, businesses are directing their ads dollar to other platforms like Tencent’s WeChat, ByteDance’s Douyin (TikTok) and BiliBili. People are spending more time on these apps instead of the Search Engine.

However, in the long run, given Baidu’s dominance in the Search Engine market, its ads revenue will not decline perpetually. But of course, the company has to continue to work on enhancing its search capabilities and monetization efforts.

iQYIYI Slowing Down

Another negative element will be the company’s previously dependent growth driver, iQIYI. This segment makes up about 25% of Baidu’s revenue for the past few years.

Source: iQIYI Q4 2020 Results / Highlights

But recently we saw that its growth has fizzled over the past year. In fact, we saw a drop in the number of subscribing members from 106.9 million in 2019 to 101.7 million as of December 31, 2020.

Baidu Stock Annual Report FY2020 / Selected Information

Source: Baidu Annual Report FY2020 / Selected Information

Overall, revenue from iQIYI did register a slight increase of about 2% for the full year of 2020. But, it continues to weigh on Baidu’s earnings as iQIYI remains unprofitable. It continues to eat up the operating income from Baidu Core’s business.

iQIYI Improving Operating Margin

Source: Business Quant / iQIYI Operating Margins

Now, the good thing is that iQIYI’s operating margin has been improving recently.

This indicates the company’s cost reduction strategy is working.

Baidu Stock Annual Report FY2020 / Selected Information

Source: Baidu Annual Report FY2020 / Selected Information

The narrowing losses from iQIYI has contributed significantly to the improvement in Baidu’s overall operating income for 2020.

In fact, this content streaming industry is expected to continue to grow in China. We will discuss this further when we talk about the growth elements of the company.

Baidu Stock New Growth Driver: Cloud Services

The second positive element is Baidu’s Cloud services segment.

Baidu Stock Annual Report FY2020 / Revenue By Segments

Source: Baidu Annual Report FY2020 / Revenue By Segments

As you can observe, this segment is growing very quickly over the past few years. Revenue increased 112% from 2018 to 2019. And then a further increase of 44% from 2019 to 2020.

This cloud business will be the next key growth driver for Baidu. The pandemic accelerated the growth of cloud computing. Businesses realized the importance of bringing their business operations to the cloud.

Baidu’s Strategy For The Future

Now that you understand what’s affecting the company, we will talk about how Baidu is positioning itself for the future.

An Artificial Intelligence Company

Nowadays, you will observe that Baidu is positioning itself as a tech company with Artificial Intelligence (AI) capabilities. Or in short, an AI company.

It is no longer the Search Engine that the company sees itself as originally when it was founded.

Since 2010, Baidu has been investing in AI to enhance search and monetization. They formed what they call the “Baidu Brain,” the core AI technology engine to develop new AI businesses.

Apart from using AI technology in its core Search Engine operation, the company is focusing its AI initiatives in 3 growth engines:

First will be its Mobile Ecosystem. This is portfolio of Apps include Baidu App, Haokan and Baidu Post. This aggregation of a wide range of third-party, long-tail content and services provides an open platform for communities to connect and share knowledge and information.

Second one will be its AI Cloud, which we saw registering tremendous growth in revenue over the past few years. Differentiated with Baidu’s AI solutions, it provides the full range of cloud services, including Infrastructure-as-a-Service (IaaS), Platform-as-a-Service (PaaS), and Software-as-a-Service (SaaS).

Thirdly will be its Intelligent Driving & Other Growth Initiatives which is associated with self-driving services, robotaxi fleets and the recently announced venture into the electric vehicle space. Other initiatives in this growth engine include Xiaodu smart devices like its smart speakers, and its AI chip development project.

Baidu Stock Growth Elements

Now, it’s time for us to estimate the growth rate for the company.

We can see that Baidu is still heavily reliant on its core business in online advertising service and the increasingly significant Cloud services. Also, not forgetting that a quarter of its revenue comes from iQIYI.

For conservative estimation, we will not touch other growth engines that the company is working on. For example, its self-driving technology and electric vehicles that are still work-in-progress.

So we will just look at growth in these 3 key segments: Online marketing services, Cloud services and iQIYI video streaming services.

Online Marketing Services Growth

First let’s take a look at Baidu’s core business in online marketing services.

Generally, growth of the advertising industry is positively correlated to the real GDP growth of a country. A stronger business environment encourages more ads spending.

Source: Statista / Growth rate of real GDP in China from 2010 to 2020 with forecasts until 2025

After an extraordinary episode with the Coronavirus pandemic, the Chinese economy is projected to recover strongly by 8.1% in 2021. Following on, China’s real GDP growth will moderate to hoveraround 5.5% for the next few years.

Source: eMarketer / Digital Ad Spending in China, 2019 – 2024

In fact, digital ad spending in China is projected to grow at an annual rate of more than 10% for the next few years.

Given Baidu’s dominance in the search engine market, its online marketing services revenue should grow with the industry. Let’s take 10% as the growth rate for its online marketing services.

Cloud Services Growth

Next will be the key growth driver, its Cloud computing business.

Source Statista / Size of the public cloud computing market in China from 2017 to 2019 with a forecast until 2023

According to Statista, China’s cloud computing market is projected to grow at a compounded annual growth rate (CAGR) of 32.6% for the next few years.

Let’s take 30% as Baidu’s cloud services growth rate.

iQIYI Over-The-Top Video Market Growth

Finally, let’s look at the growth potential of iQIYI.

Source: PwC / Global Entertainment and Media Outlook 2020-2024: China summary

According to PwC, China’s over-the-top (OTT) video market will grow at a CAGR of 12.2% from 2020 to 2024.

Let’s use this 12% as the growth rate projection for Baidu’s iQIYI business.

Baidu Stock Overall Growth

Now, we have some growth figures to work with. Let’s estimate the overall growth rate for Baidu for the next few years.

We will use a weighted average growth rate of each of the 3 key segments to derive an overall growth rate.

Since its online marketing services, cloud services and iQIYI streaming services account for 62%, 8.6% and 27.8% of Baidu’s revenue respectively, we can derive a weighted average growth rate to be:

(10% x 62%/98.4%) + (30% x 8.6%/98.4%) + (12% x 27.8%/98.4%) = 12.3%


Baidu Stock Price 1 Year Chart

Source: Yahoo Finance / Baidu Inc Share Price Chart 1 Year

With the current market correction, I think it presents an opportunity for investors.

Baidu Stock Overview

Source: Yahoo Finance / Baidu Inc Summary

At a Price-to-Earnings ratio of around 20, the risk of multiple compression is lower compared to previously. And it still presents an opportunity to ride with the growth of the company at more than 12% a year.

And that’s not accounting for the profitability of iQIYI streaming services, which is currently still in the red and dragging on Baidu’s operating income.

Once iQIYI’s business and its Cloud computing operation becomes profitable, there will be more value to be uncovered in Baidu’s shares.

Also, we have not accounted for the invested capital that the company is ploughing back to grow its business.

So, I’m definitely adding Baidu stock to my portfolio. And you can consider as well if the risks and returns profile is good for you.

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Keep learning and happy investing. 🙂

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