Baidu (NASDAQ: BIDU), along with other top Chinese technology stocks such as Alibaba (BABA), have come under intense scrutiny over the past decade. However, even in these difficult times, the company has proven to be very resilient; not only has it weathered the storm, but it is in an excellent position to thrive. Specifically, Baidu demonstrated considerable strength on two important metrics, namely 1) underlying operating cash flow generation and 2) balance sheet strength (more on this below).
So far this year, the markets are going through a manic-depressive phase. Market sentiment is fragile and broad equity indices have come under significant pressure, with headlines awash with negative news. In addition to high inflation, interest rate hikes, supply chain disruptions, ongoing COVID-19 concerns, a possible monkeypox outbreak in 2022, and the war in Ukraine, we We now also have concerns about Taiwan, exacerbated by Nancy Pelosi’s visit to the island. As a result, in June, the S&P 500 entered bearish territory, falling more than 20% from its highs. This is the worst performance since the early days of COVID-19 (March 2020). The good news is that in July sentiment improved significantly. In fact, July was the best month since 2020. So in just a few months, we went from the worst performance since March 2020 to the best performance since 2020. Additionally, the positive momentum continues to build in August, so that US inflation declined in July and wholesale inflation actually fell (due to lower energy prices), another sign that price increases are slowing. Improving inflation data sparked a rally in equity markets.
Earlier this year, mainly in Q1 and June/July, Baidu was actually doing much better against major US indexes, thanks in part to the gradual easing of China’s tech crackdown.
However, sentiment in China is turning gloomy again, especially after Pelosi’s visit to Taiwan, adding even more pressure to already strained US-China relations. Even so, and despite the recent rally in US markets, year-to-date Baidu still outperforms the tech-heavy Nasdaq and S&P 500, which are down 16.6% and 10.2 %, respectively, and delivered similar results. performance at the Dow Jones which is down 5.61%.
Not only did Baidu outperform most major US indices, but it also outperformed all of its Chinese tech peers, by a wide margin:
Baidu released strong results in the first quarter of 2022despite the challenges posed by the resurgence of COVID-19 in China. RResults exceeded expectations, driven by continued strength in its core business, particularly non-online marketing revenue and cloud services, with non-advertising revenue growing 35% year-over-year, driven by to Baidu AI Cloud, which grew 45% year-over-year. Overall, Baidu remains extremely profitable, generating adjusted EPS of $1.77 on $4.48 billion in revenue (vs. estimates of 83 cents per share and $4.16 billion in revenue), underlying operating cash flow generation remains stable and the balance sheet is awash. with money.
Importantly, Baidu’s operating cash flow resilience and ability to hoard cash is not a recent phenomenon. In fact, it has been for over a decade.
The cash balance has skyrocketed at a very rapid rate, to almost $30 billion, largely due to strong and consistent cash flow from operations. Importantly, the cash balance grew at a much faster rate compared to the long-term debt. However, despite the huge cash balance and ability to generate substantial operating cash flow, Baidu’s market capitalization remains depressed, below $50 billion. To put things into context:
- cash and short-term investments account for nearly 60% of Baidu’s current market capitalization
- net debt is negative because the company has more cash than long-term debt
- net cash represents more than 30% of current market capitalization
Based on the above, Baidu is very cheap. In fact, even though global markets have performed exceptionally well over the past decade, Baidu has been dead money with the stock price hovering around 2011 levels. especially as Baidu’s cash position is near record highs and will continue to grow due to strong operating cash flow, all things being constant. To be fair, Baidu isn’t the only cheap Chinese tech name. For example, I recently covered Alibaba and came to similar conclusions. However, for a company to blindly suffer simply because it is of Chinese origin is inappropriate. In fact, Baidu is one of the world’s biggest brands, being among the world’s 100 most valuable brands, ranking ahead of giants like Uber (UBER). Moreover, even though Baidu is often referred to as the “Google of China”, since it dominates over 70% of China’s market share, it is much more than just a leading search engine. For instance:
- Baidu has made substantial progress on cloud computing and chips (Kunlun was recently spun off)
- Baidu owns a majority stake in iQIYI (IQ), often referred to as the “Netflix of China” (note: Baidu plans to sell all of its stakes in iQIYI for around $7 billion)
- Baidu has established a world-leading position in AI, including self-driving technology through Apollo, which includes robotaxis and robobuses, and recently unveiled its next-generation fully autonomous vehicle Apollo RT6, a fully production-ready electric with removable steering wheel. Baidu’s robotaxi is expected to cost half the cost of a taxi today
- Baidu’s electric car startup Jidu Auto, a joint venture between Baidu and Geely Automobile (OTCPK:GELYF), is reportedly valued at around $3.5 billion, based on a new funding round of $300-400 million dollars, as it seeks to launch its first commercial vehicle in 2023.
Therefore, in addition to its legacy research business, all stars are aligned for Baidu to also become a global force in AI, electric vehicles, intelligent transportation and more. Yet, despite the remarkable progress, Baidu’s share price remains stagnant, as shown above. This situation cannot last forever. Not only is Baidu making meaningful progress on so many exciting strategic initiatives, but its cash-rich balance sheet continues to strengthen. Why? Because Baidu already generates substantial and consistent operating cash flow, allowing it to invest in its future as well as hoard cash. Once these initiatives bear fruit, they will generate even more substantial operating cash flow. Few companies find themselves in such a fortunate position. Therefore, I can only conclude that the market is in hibernation mode or assume that Baidu will find it difficult to grow. But there are no credible signs that Baidu will struggle to grow, partly for the reasons discussed above. Baidu is not a complacent company. In fact, it has heavily invested billions of dollars in R&D over the years (this year R&D spending was up 10% year over year). But let’s have fun with the pessimistic scenario that Baidu will struggle to grow. To this end, I assume the following scenario:
- 10 year investment horizon
- Annual run rate of $3 billion in operating cash flow (which is lower than 2015 levels, which is quite pessimistic)
- Static world, i.e. the annual operating cash flow will remain constant at $3 billion, and this cash flow will not be reinvested, i.e. it will accumulate simply on the balance sheet (i.e., no investment outraged Maintenance CAPEXzero innovation, zero M&A activity, zero dividends, zero share buybacks, etc.)
In this pessimistic and static scenario, over a period of 10 years, Baidu will accumulate more than $20 billion in cash, or about 50% of its current market capitalization. This, combined with the existing cash balance of approximately $30 billion, means that in 10 years more than 100% of the current market capitalization will be in cash. This provides a huge margin of safety, but it’s also extremely pessimistic of a scenario. In reality, Baidu will innovate, expand originally, acquire other companies and repurchase shares. Eventually, the inflated cash position, growing cash flow and growing EPS will “force” the market to re-price Baidu to much higher levels. Thus, patient investors should benefit. Unless Baidu’s products become obsolete. The chances of that happening are extremely low, in my opinion.