Baidu

Baidu: Buy if you are not afraid of radiation, iQIYI risks

JasonDoiy/iStock Unreleased via Getty Images

Main thesis

In 2022, the infrastructure risks that caused the selloff a year earlier continued to put pressure on Chinese ADS stocks. The worsening volatility in Chinese equities has not escaped Baidu, Inc. (NASDAQ: BIDU). Baidu is down 20.2% since the start of the year. It is still better than the performance of the sector.

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Data by YCharts

Many investors think the risks are overstated and view stocks as undervalued. So if you don’t really fear China, Baidu’s case is still strong and the title looks attractive.

Why should you be afraid

By law, all US-listed companies must file audit reports certified by accounting firms directly with the SEC or they will be delisted from US stock exchanges. This becomes a real delisting risk for Baidu as Chinese regulators are unwilling to transfer necessary information overseas. In late August, the WSJ reported that the United States and China had reached an audit agreement. However, according to Reuters, citing the South China Morning Post, China would only allow the release of redacted audit data, which would not sit well with US regulators. The publication notes that similar points were already reached in 2016, but the Chinese government later decided to withhold the information.

Additionally, it is important to remember the important role of the Chinese Communist Party in Baidu’s affairs, as the company is regularly subject to huge fines. These risks should always be kept in mind when investing in Chinese companies. I think they completely overshadow the whole positive investment thesis about investing in Chinese ADSs.

Another weakness of Baidu is the stagnation of the iQIYI (IQ). The number of “Chinese Netflix” subscribers fell to 98 million from 101 million in the first quarter of 2022. iQIYI, although one of the most popular online entertainment services, is still unprofitable and stagnant. The service was originally intended for large series and quality shows, but in the last 7 months the creative process has come to a standstill again. In general, the platform is a stopper for the development of Baidu’s AI directions and a kind of hole in the budget. At the end of February, the service’s management requested $285 million from the parent holding company Baidu to carry out several projects. iQIYI places a heavy burden on the business.

absolute leader

Baidu’s search engine is the undisputed leader in China. The company provides a search engine that has virtually no alternatives for Chinese residents, as Western counterparts are mostly blocked in the country.

Bing and Google occupy less than 10% of the market and are not expected to grow further due to the full control of the authorities over the information space. Sogou, on the other hand, is a niche story albeit a rapidly growing one.

search engine market in china

Baidu’s share in the Chinese search engine market (StatCounter)

Baidu’s size gives the company a huge advantage over its competitors. In the second quarter of 2022, Baidu APP’s MAU increase to 628 million and daily connected users reached 84%. This creates a massive network effect. User queries optimize search engines, so Baidu’s dominance in this segment should help the platform deliver more accurate results than its competitors. This allows them to keep traffic acquisition costs low and at the same time attract more advertisers.

The company’s efforts to build its own content ecosystem through the Baijiahao platform, smart mini-programs and managed landing pages will also boost its competitiveness and user retention.

AI projects

IDC appointed Baidu as the top cloud service provider in the Chinese market in its IDC 2022 H1 Report. Developers and businesses can easily access and build custom AI solutions for various industries using Baidu’s cloud-based modular solutions set. Baidu provides a wide range of AI services in the areas of speech recognition, computer vision, natural language processing, optical character recognition, video analytics and structured data analysis .

China provides a solid foundation for the development of AI. According McKinseythe development of AI in the country could add $600 billion to the economy by 2030. The state is interested in the development of these technologies.

Separately, it is worth noting the merits of the company in the field of autonomous driving. Baidu’s Apollo system supports L3 and L4 levels of autonomous driving and is equipped with HD maps to enable vehicles to drive intelligently on urban roads. Apollo Go completed 287,000 rides in the second quarter, up 46% from the first quarter. The company already has strategic partnerships with automakers to equip their passenger cars with upgraded Apollo systems. This segment currently generates insignificant revenues. However, the business has great potential as the market is expected to grow rapidly in this decade. According EqualOcean citing Yi Guan Analysis, the market size will reach 350 billion yen ($52.3 billion) by 2030 and Robotaxi’s penetration rate will increase to 55%.

Chinese robotaxis market

EqualOcean

In recent years, Baidu has invested heavily in research and development through Baidu Ventures. The company intends to increase the number of projects to enter new markets, which is a positive sign for long-term investors.

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Data by YCharts

Evaluation

Baidu seems undervalued compared to the American search engine giant Alphabet (GOOG, GOOGL). The stock trades at a low EV/EBITDA of 7.3x, compared to Alphabet’s 10.2x.

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Data by YCharts

This nearly 30% discrepancy is due to environmental risks and Baidu’s revenue stagnation in recent years. And if nothing can be done about environmental risks, revenues should recover as advertising activity normalizes. Baidu is cheap, and if institutional investors start to return to China, we can expect the valuation gap between overseas peers to narrow.

Conclusion

Baidu, like all Chinese stocks, carries incredible structural risks that cannot be ignored. But besides this factor, the company has good prospects. It has a strong business base in search engines and advertising, which dominates the market, and many very promising and fast-growing AI projects.

Baidu’s position appears to be stronger than that of other Chinese tech giants, such as Alibaba (BABA, OTCPK: BABAF) or JD.com (JD, OTCPK: JDCMF), because the company’s core business is not subject to competitive pressure. Market monopolization allows Baidu to set its own rules and raise prices.

Overall, if you believe the delisting risks will not materialize, CPC will ease the pressure on private companies and the ballast in the form of iQIYI will ease, then BIDU will look like a solid long-term buy.