(Reading time: 21 minutes)
China’s internet services sector is booming, and it’s no news. Tech companies from the Celestial Kingdom are well known everywhere and often listed in the American markets to attract more capital.
In the whole world, Google has supreme control of the search engine market. In China, however, the American company is banned.
Baidu, instead, is the biggest search engine in Mainland China.
Not only that, but it is also the second-largest search engine in the whole world.
Considering Baidu only for its search engine would be overly reductive: the company offers more than sixty search and community services, the vast majority of which in the Chinese language.
AI is considered one of the most sought-after technologies of the current times. The Asian company invests heavily in its development and joined in 2018, as the first Chinese firm, the US-based computer ethics consortium “Partnership on AI”.
If you are interested in tech companies, why limit the readings to Amazon, Apple and Google? There’s more out there, especially in Asia. Read along!
1. The Company
Robert Li, a Chinese young man holding a bachelor’s degree, decides to move in 1991 to the US for a doctorate in computer science. In 1994, Li chooses not to continue with the Ph.D. and gets a master’s degree.
Shortly after, he joins IDD Information Services, a division of Dow Jones and Company. During his time at the company in New Jersey, working on the online edition of The Wall Street Journal, he develops “Rankdex”, an algorithm for search engine page ranking.
Li registers his invention with a US patent. The papers to get the patent will also be referenced two years later by Larry Page (Google co-founder) while registering PageRank.
In the meantime, Robin changes employment and goes to work for Infoseek, one of the first internet search engine companies, and works there from 1997 to December 1999.
In January 2000, Mr. Li cofounds Baidu, using his Rankdex algorithm to rank pages in search engines. The other founder is Eric Xu, who will fade from the company ranks in 2004.
The name “Baidu” comes from an ancient Chinese poem and means “100s of times”.
“Making information available to all equally” was the mission of the early days of Baidu.
Li and Xu finance the initial phase of Baidu with funds of around $1.2 million, raised among several investors in Silicon Valley.
At first, the search engine built by Robin Li is used on other major portals such as Sina and Sohu. In 2001, however, after the “internet bubble” crisis, Li uses the algorithm to create Baidu.com and its proprietary search engine.
In 2002, Baidu moves to Ideal International Plaza, still in Beijing. In the same year, the efforts are working towards the “Lightning Project”: overtake Google in the Chinese-language search engine. The project turns ultimately into a success!
For Sinovation Ventures’ CEO Kai-Fu Lee, the overtake of American businesses in China is a reality only because US companies are used to employ a “one-size-fits-all” approach.
Instead, China is a so significant and so diverse market to be needy for more attention and accuracy.
Baidu’s growth continues rapidly while added new features, such as the 2003 news search engine and picture search engine.
On August 5th 2005, Baidu is listed on Nasdaq to stop a takeover bid, using a variable interest entity based in the Cayman Islands. The early investors want to sell and capitalize on the profits. Rumors indicate the senders of the offers being Google, Microsoft, and Yahoo!
Robin Li realizes to have made the correct decision in turning those major companies down when from the $27/share of the opening, the price spikes to $66/share for the first sale price and reaches $151/share shortly after.
The release of the first iPhone in 2007 and of the first iPhone 3G in 2008 indicate to Baidu the necessity to work on mobile versions of its numerous search engines.
The goal to overtake PC searches with mobile searches is introduced between 2013 and 2014. Robin Li understands that smartphones will have a disruptive effect on his company.
A strange domain name redirection attack happens in January 2010: the Iranian Cyber Army can retrieve the access password to Baidu.com’s admin page, thanks to a gross error from the technical support staff of Register.com. The redirection lasts four hours, and the whole story ends up with Baidu and Register.com in court. Shortly after, the companies find an agreement with a settlement.
In 2012, Baidu forms two partnerships: with Sina to provide mobile search results and Qualcomm to offer free cloud storage to Android users with Snapdragon processors.
In August of the same year, three employees are arrested, suspected of accepting bribes. They will be fired soon after.
In August 2013, Baidu announces that its wholly-owned Hong Kong subsidiary has merged with 91 Wireless Web-soft Limited for $1.85 billion. It is the biggest deal ever in China’s IT sector.
In 2017, the company announces to be working on developing a self-driving vehicle platform to help drive the development of autonomous cars. The commitment is significant, with Baidu interested in developing vehicle platforms, hardware platforms, software platforms, and cloud data services.
To accelerate this process, Baidu partners with Continental and Bosch.
These partnerships allow the company to produce its first driverless bus in 2017.
Mr. Robin Li is the co-founder, chairman, and chief executive officer of Baidu and oversees its overall strategy and business operations.
Robin received a Bachelor of Science degree in information management from Peking University in 1991 and a master of science degree in computer science from the State University of New York at Buffalo in 1994. Robin worked as a senior consultant at Dow Jones’s subsidiary and designed the Wall Street Journal’s online edition’s real-time financial information system. Robin received a US patent for a hyperlink analysis system in 1999, one of the inventions that has helped shape today’s search technology. He later joined InfoSeek, one of the early search engines, in Silicon Valley as a senior engineer.
In 2000 he co-founded Baidu and led it till today, with incredible results.
Mr. Li is one of the most respected entrepreneurs globally. He serves on the board of New Oriental Education & Technology Group Inc., a private educational services provider in China (NYSE: EDU), and Trip.com, an online travel agency in China (NASDAQ: TCOM).
Mr. Herman Yu served as Chief Financial Officer since September 2017. Previously, he worked for Weibo Corporation (NASDAQ: WB) and SINA Corporation (NASDAQ: SINA), a web portal.
Yu holds a Bachelors degree in Economics from the University of California, Santa Cruz, and a Masters degree in Accountancy from the University of Southern California.
Mr. Haifeng Wang is the Chief Technology Officer of Baidu since May 2019 but joined in 2010. He oversees the AI lab, systems & technology, and cloud group.
Dr. Wang holds a Bachelor’s, a Master and a Ph.D. degree in Computer Science from the Harbin Institute of Technology.
2. Qualitative Analysis
Business Model Spotlights
Baidu’s business model is focused primarily on the core of the company: search engine monetization. In fact, through its network of more than 60 platforms, the firm can reach virtually any person inside Mainland China. During recent years, its services also expanded to other countries, such as Brazil, Egypt, Indonesia, Japan, and Thailand.
The management divides the business into two major segments: Baidu Core and iQIYI.
Baidu Core is a group of products and services that made the company successful, such as search engines and AI solutions.
iQIYI is instead an online entertainment service provider in China. To simplify, it is a video streaming platform with professionally produced, partner generated, and user-generated content. Subscribers to this platform reached 101.7 million in December 2020.
Baidu’s structure looks as follows:
The search and feed segment includes apps like Baidu App, enabling users to access Baidu’s proprietary search engine, feed, and other accessory services.
The same can be done through Baidu’s online search on any of the portal of the group.
Interestingly, to drive more traffic to Baidu’s pages, the company proposes also Haokan, a short video app, and Post Bar, a social media platform that builds online communities based on topical interest.
Knows is instead a query-based searchable community to share knowledge and experiences.
Moreover, the group also powers Baidu Encyclopedia, compiled by experts of any sector, Baidu Maps, and Baidu Input Method Editor, a keyboard focused on the peculiarities of the Chinese language.
As previously said, Baidu is also present in some countries overseas. The most internationally known products outside of Mainland China are popIn, an ad recommendation platform, Simeji, the most popular mobile keyboard in Japan, and Facemoji, Simeji’s international edition.
All these services fuel the system of auction-based P4P services, allowing customers to bid for priority placement of paid sponsored links to reach better users seeking that specific information or product.
In the last years, Baidu invested heavily in developing new AI business initiatives and Cloud services. Among its AI businesses, Baidu invests in DuerOS, a cross-platform voice assistant with an installed base of 400 million as of 2019, and Apollo, an open-source autonomous driving platform that supports the commercial production of self-driving vehicles.
Baidu Cloud, instead, provides AI solutions, cloud infrastructures, and accessory services to enterprises and individuals. This segment of the company aims to offer a comprehensive set of products, services, and tools to enable enterprises to improve productivity and operational efficiency through Baidu AI and cloud infrastructure.
Baidu’s revenues can be divided into three main parts: Online marketing services, non-marketing services, and iQIYI sales.
As clearly recognizable in the pie chart below, Baidu gets the vast majority of its revenues through online marketing services. These items amounted to $10.16 billion in full-year 2020, for a share of 61.2% on total revenues.
iQIYI follows, with $4.55 billion of sales, accounting for 27.4% of the total.
Non-marketing activities have a relatively low share of contribution in Baidu’s business: they account for “only” $1.9 billion in sales, 11.4% on the total.
The core business is having a hard time growing at favorable rates; however, the management is implementing a change in its overall strategy focusing on other sectors.
Will Baidu continue to play an essential part in the Chinese economy, or will it turn into a falling star?
We think that Baidu can grow further, but last year’s results are difficult to overtake, and the competitors are strong.
Competitors, threats and overlooked opportunities
China’s technology and online services sector is thriving. Tencent, Alibaba, Baidu are some of the best-known names when it comes to Chinese companies.
They also happen to be all in competition with each other in some of their numerous business segments.
Baidu is encountering growing competition from Tencent’s WeChat, the social network and messaging app. WeChat, with 1.213 billion users in 2020, is a real threat to Baidu’s legacy.
In 2017, Tencent introduced a search function in its core social network, powered by Baidu’s direct competitor Sogou (NYSE: SOGO), and a series of mini-programs that allow users to access several apps and services without leaving the app.
Also Baidu introduced mini-programs in its apps, but the user base is still low.
Tencent has the potentiality, in the next few years, to overtake Baidu in its core business.
Alibaba is still the leader in the market of digital advertising platforms. Recent changes, however, happened recently behind Jack Ma’s group. Baidu has been taken over by TikTok and Toutiao, both subsidiaries of ByteDance. These apps, top-rated among generation Z teenagers, are growing their customer base internationally and in Mainland China.
ByteDance entered a war of search engine traffic officially with Baidu when, in 2018, it introduced a search function in Toutiao.
It’s not only a war on search engines but also on content quality. Baidu can leverage the user base of Haokan, the short video app (a competitor of TikTok), and the proprietary news app. However, both of the apps are falling behind the rowling power of ByteDance and its subsidiaries.
Alibaba is also a competitor of Baidu when it comes to search engines and cloud infrastructure. Shenma is the second-largest mobile search engine in China, and it’s the property of Jack Ma’s group. This platform is relatively small, but with the help of a better relationship with several Chinese retailers could reach a dangerous position for Baidu.
Baidu’s cloud infrastructure is undoubtedly not the group’s leading business and doesn’t attract as many clients as Alibaba Cloud, which controls half of the market. The chasm between those two services’ power could widen if Alibaba decided to send prices of its services down to levels impeding Baidu to grow.
In January 2021, Baidu announced it be interested in pursuing electric vehicles’ productions, using a strategic partnership with Zhejiang Geely Holding Group.
Analysts estimate Baidu’s Apollo project’s value to be around $32 billion, and the segment is expected to produce $8.3 billion in revenues in 2023.
In this segment, Baidu has surely relevant competitors in Mainland China: NIO, Li Auto, and Xpeng are ready to fight Tesla’s legacy.
Even though the competitors in this segment are numerous and robust of piles of cash, Baidu has the power to make happen the next grand shift in the car industry. The focus is not anymore on the production of Electric Vehicles, but on making them smarter! Apollo’s AI technologies’ employment could lead Baidu to produce in some years cars that are not only fully electric but also smart and capable of self-driving and self-behaving.
Baidu, then, has the potential to fight the competition on Electric Vehicles empowering its AI knowledge.
3. Quantitative Analysis
Baidu, Inc.’s financials present a company that slowly grows no matter what the economic situation.
Figures in the statements are presented in million dollars.
The revenues are stagnating around 16 billion dollars, with a slight growth between 2018 and 2019.
The encouraging piece that can be taken away from these financial statements is that Baidu’s management, conscious of the fragility of its long-term revenues in the core business, is trying to expand the firm’s sectors.
“Other revenue” figures grew rapidly in the last three years, giving hope of long-term growth to Baidu’s shareholders.
The company is investing heavily in research to further develop AI solutions, with a clear target of entering the market of autonomous driving in mind.
Should the company enter the intensively competitive market, these “Other revenues” could further grow and become the first component of Baidu’s income statement.
While the company is facing severe competition in its core business, self-driving cars could be a welcoming and more profitable sector in which to grow.
Online marketing services related revenues are shrinking, with the company needing a severe shift in its overall strategy. These sales went down from $12.7 billion in 2018 to $11.3 billion in 2020, decreasing even in 2019 when, amidst the pandemic, online companies were the only ones to perform.
During the pandemic, Baidu suffered intensively and had to sustain more considerable costs to afford the production of revenues.
The company grew homogeneously in its assets while sustaining this with the help of current liabilities.
The balance sheet composition is correct, with a debt to equity ratio of 0.71 and an overall healthy outlook of the margins. The current liabilities can quickly be repaid with the large amounts of cash on hand and with other receivables.
Let’s jump into the comparative analysis and try to see how Baidu is positioned compared to its peers!
The comparative analysis started with a large selection of stocks from the online media and internet sector in general. However, we also included companies operating in the new electric vehicle sector. Below is the first list of peers for performing a comparative analysis.
After spreading the numbers, we noticed that some companies, especially the ones operating in the car manufacturing industry, weren’t representative of the current situation of Baidu’s operations.
For this reason, we decided to narrow down the list to internet companies that are laterally investing in other sectors. For example, Apple, Google, and Tencent are all involved in joining the electric vehicle industry.
The first ratios considered are the price-linked ones: price on earnings is the competitors’ median value, with a slightly higher price on earnings forward.
Price on sales is also in line with peers, even though it lays on the low-end, which is a positive sign correlated with a low price overvaluation regarding revenues.
Price on book value also shows that Baidu’s current market value lays close to what is reported in the financial statements.
The cash flow ratio is in line with its peers, especially if considered that Chinese companies seem to tend to have higher P/Cash flow ratios than American ones.
We proceeded further with EBITDA and EBIT Enterprise Value multiples, with Baidu that presents the signs of overvaluation, together with Tencent, if compared to all the peers. The margins are considered the median figure of the data sample. Returns are lower than those of the peers, which could impact the overall EV valuation. Baidu is more geared than the mean and average value of debt but still in the right area.
Performing a DCF Analysis can help us give an actual value to Baidu’s stock and a synthetic price that explains that value correctly.
In calculating the correct Weighted Average Cost of Capital for Baidu, we considered several different values.
The table below serves as a synthetic summary of this consideration.
After finding out the yield to maturity of Baidu’s corporate bonds currently in the market, we estimated the tax rate to find the firm’s net cost of debt. The value found is 1.15%.
The risk-free rate was provided by the yield of the 10Y Government bonds of China. Both the country risk premium and the equity risk premium were retrieved from Professor Damodoran’s pages at the Stern School of Business School at New York University.
The beta chosen is an industry adjusted beta provided from SeekingAlpha.
The total cost of equity is then equal to 8.7%.
The debt to equity mix of Baidu is currently 42.74% to 57.26%, so this proportion was reflected in the WACC calculation.
At this point, we proceeded to forecast the EBIT progression in the next five years, and we reached a synthetic value for FCF.
Then, after calculating the firm’s Terminal value in 2025 both from a perpetual growth point of view and an EV/EBITDA one, we reached the correct enterprise value.
The table below is an indication of the results found with both methods.
We assumed a conservative perpetual growth since current inflation in China is negative, but GDP growth is positive. The perpetual growth rate chosen is, for this reason, 1%. Even if the company continues to grow, it will change its structural strategy, which could bring unfortunate surprises.
The EV/EBITDA multiple considered was the average value for all the peers previously considered.
We feel that the price per share of $345 represents the value of Baidu correctly: a good company ongoing a strategic shift, but with great perspectives of growth.
Baidu’s chart showed quite some volatility recently, with the stock reaching an all-time high of $354.82/share on February 22nd.
In the long term, the stock shows bullish signs, with a correction in the short to mid-term. Before reaching the all-time high, the stock went down to the 288.15 area, which was then retested on February 23rd. This area could have turned into support, possibly suggesting that sellers will try to push the stock price down towards that level again in the next few days.
Moving averages seem about to close and cross around the 1st of March.
At that point, the correction should allow the buyers to come back in the trend and push another rally.
The Average Directional Index shows a mild value of around 25 at the moment, signaling the absence of a strong trend. One of the factors to consider after the correction happens should be the value of this indicator, with a reading over 40 showing a trend.
Peter Lynch company category
Baidu is a clear stalwart if considering the legendary investor Peter Lynch’s stock categories.
Baidu can turn into a fast grower with the strategic shift closer and closer if the bet on the cars’ market goes as planned.
Risk 1: Global political relations
While many thought that the start of the Biden administration at the White House would be the turning point for China-US political relations, recent news signal the contrary.
Even if Biden is more inclined to dialogue, it doesn’t necessarily mean that getting out of this situation will be easy and timely.
The relationship is deteriorating even further, with Taiwan becoming the lightning rod in US-China tensions again.
Interestingly enough, Germany is seeking a strategically “equidistant” position rather than an alignment with any of the two powers.
Together with the European Union, Germany could be the unlocker of the cooperation between the US and China.
For German cars and other products, the Chinese market is too important, especially in a pandemic period and a contraction moment for the Western World.
The risk here is the perpetrating of US-China tensions and the worsening of the relationship.
Risk 2: Competitors leveraging weak spots
Baidu’s competitors are attacking from any side of the business. The long-term core business is visibly suffering.
With all the companies trying to steal the market to the search engine firm, margins could become tight, and revenues reach low bottom levels.
The risk associated with the upcoming shift in strategy is about losing Baidu’s bets and succumbing to the other market players.
5. Conclusion & Investment Strategies
Baidu is still the biggest search engine company in entire Mainland China. However, pressures are requiring a change in the business strategy and revenue streams.
Considering that iQIYI and the other revenue streams still have plenty of ways to grow during the next years, overall growth is foreseeable, even if slow.
The current valuation of $345/share makes sense at the moment, even if this is not the perfect time to buy.
As stated in the technical analysis paragraph, the stock will probably undergo a correction period, with the price resuming the bullish phase only, presumably, during week 9.
We suggest a buy around the $290-300 area and then hold for the years to come. The stock is not for short-term speculation, and for this reason, we can’t suggest an option strategy.
Disclaimer: Our content is intended to be used solely for informational and educational purposes, and not as investment advice. Always do your research and consider your personal circumstances before making investment decisions. ChineseAlpha is not liable for any losses that may arise from relying on information provided.