Baidu

Baidu Stock: Google from China, but cheaper (NASDAQ:BIDU)

Kevin Frayer

Baidu (NASDAQ: BIDU) (HK:9888) is a diversified technology company that really is the “Google of China” in my opinion. The company owns the most popular search engine in the country, has a thriving advertising business and a rapidly growing cloud segment. Baidu is also strong is progressing with its “Robo Taxi” division which is already operational in many Chinese cities. Market fears over Sino-US tensions and government intervention caused Chinese stocks to sell off sharply. Baidu’s share price has fallen 50% since March 2021, although the company has exceeded estimates for revenue and profit growth in the second quarter of 2022. In this article, I will detail the financials and valuation of society, let’s dive into it.

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Data by YCharts

Strong finances

Baidu generated strong financial results for the second quarter of 2022. Revenue was $4.43 billion, beating analysts’ estimates of about $42 million, despite a decline 5% year over year. Baidu Core makes up the majority (78% of that revenue) and was down 4% year-over-year. This was mainly due to lower advertising revenue due to macroeconomic concerns and strict Covid restrictions in China. In my article on Google (GOOG) (GOOGL), I also pointed out a similar problem because the advertising market is cyclical. Also, advertisers tend to follow each other like sheep, when you pull the spend they all do. The 618 Shopping Festival was a tailwind, which helped offset some of the decline in customer advertising spend.

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Data by YCharts

A thriving cloud business

Similar to Google Cloud, Baidu has a cloud services business called “AI Cloud”. This is the fastest growing part of the business with revenue of $2.1 billion (RMB 15.1 billion) in the second quarter. Baidu reports its Cloud business under “non-marketing” revenue in its “Baidu Core” segment. Digital transformation is still in the early stages of development in China as more companies move their IT workloads to the cloud. A McKinsey study estimates that the value of China’s public cloud market will triple by 2025, from $32 billion in 2021 to $90 billion by the end of the period. Analysts predict that this will be due to the large number of manufacturing companies in China. Management predicts profitability as the business scales and I believe them given that western cloud service providers such as AWS, Google Cloud and Azure are the most profitable parts of the big three tech giants. Alibaba (BABA) Cloud holds the largest market share in China, capturing around 37% of cloud-related spending. Baidu AI cloud ranks fourth with a 9% market share, but this is still solid considering the size of the growing market. Additionally, Baidu’s focus on artificial intelligence workloads could be a key differentiator.

Cloud Providers in China

Chinese cloud providers (China Internet Watch)

Robotaxi King

Baidu is a leader in self-driving vehicles in China with its Apollo Go Robo Taxi which is far more advanced than Google’s Waymo to the west. Apollo Go already has a presence in more than ten cities across China and charges customers a fee for its ride-sharing service. Each “Robotaxi” vehicle makes around 20 trips a day and its new RT6 model now sells for a price similar to that of a consumer electric vehicle. One key point that no one seems to be talking about is that Robotaxis might actually be a favorite necessity for people in China. The country is still facing ongoing lockdowns and hence people tend to prefer not to interact with others. Therefore, there is no better way to do this than with a Robotaxi that does not have a driver who would interact with many customers. Also, the platform is already working in Wuhan, so I think it could further accelerate adoption, depending on how the company markets the product.

The autonomous vehicle industry is expected to grow at a rapid compound annual growth rate (CAGR) of 40.1% and be worth over $2.1 trillion by 2030.

China’s Netflix (NFLX)

Baidu also owns the largest video streaming platform in China, which is called iQIYI (IQ) and is often referred to as the “Netflix of China”. The company generated $994 million (RMB 6.7 billion) in revenue in the second quarter of 2022, which was down 13% year-on-year, due to cyclical rotation consumer habits. The good news is that its revenue cost was $2.27 billion (RMB 15.2 billion), which was down 5% year-on-year as the company increased efficiency of its content spending. Despite the headline gains, this improvement in efficiency translated into positive operating profit for the second consecutive quarter.

Improve profitability

Baidu generated an overall operating profit of $508 million (RMB 3.4 billion), which was up 24% year-on-year. Earnings per share were $1.44, which beat analysts’ estimates of $0.53. The company has a solid gross margin of around 48% and an operating profit margin of between 8% and 17%, which has been fairly consistent despite being somewhat cyclical. The business also generated strong free cash flow of $823 million (RMB 5.5 billion).

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Data by YCharts

Baidu has a strong balance sheet with $28.28 billion in cash, cash equivalents and short-term investments. The company has a fairly high debt of $14.2 billion, but “only” $2.8 billion of that debt in the short term (due within the next two years).

Advanced Assessment

In order to value Baidu, I incorporated the latest financial data into my advanced valuation model which uses the discounted cash flow valuation method. I have projected a conservative revenue growth rate of 5% for next year and revenue growth of 10% over the next 2-5 years. I expect this to be driven by the continued growth of the cloud segment and the cyclical rebound in the advertising market.

Baidu stock valuation 1

Baidu stock valuation 1 (created by author Ben at Motivation 2 Invest)

I capitalized the company’s R&D expenses which adjusted the operating margin from ~13% to nearly 19%. I expect this adjusted margin to increase to 24% over the next seven years as the company’s cloud segment grows, iQIYI continues to generate higher profits, and the popularity of self-driving increases.

Baidu stock valuation 2

Baidu stock valuation 2 (created by author Ben at Motivation 2 Invest)

Considering these factors, I obtain a fair value of $168 per share, the stock is trading at $108 per share at the time of writing and is therefore undervalued by around 36%.

As an additional data point, Baidu is trading at P/E = 12.99, which is 52% cheaper than its 5-year average. Baidu is trading at a significantly cheaper PE ratio compared to Alphabet which is trading at a PE=19. However, the company is not as cheap as Alibaba which is trading at a PE=10, but this business has a lot more negative headwinds.

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Data by YCharts

Risks

Sino-American tensions

There are growing tensions between the United States and China, regarding data privacy, accounting and much more. Baidu is listed on the Hong Kong Stock Exchange under the symbol HK:9888, and I don’t believe the company is listed on the New York Stock Exchange, which means delisting is not an issue. Baidu also trades on the OTC exchange under the symbol BAIDF, but this exchange offers less liquidity, which could impact institutional investors. The Chinese government also plays a key role in decisions governing tech giants in their region. Alibaba was fined $2.8 billion and Tencent was also fined in the past. Baidu has mostly flown under the radar, but that doesn’t mean they aren’t always exposed to the same risks. Therefore, it makes sense to provide a “Chinese risk” allocation for all stocks in the region.

Recession

Many analysts predict a recession in the West due to high inflation and rising interest rates. China managed to keep its inflation rate low at just 2.5% for September, which is relatively similar to historical levels after a brief spike at 6% in 2020. However, as China derives the majority of its GDP exports, a recession in the West will also impact them. Additionally, China has a leveraged housing market that some analysts say is close to economic collapse. Beijing’s “Zero Covid” containment policy is also having an impact on economic activity.

Final Thoughts

I think Baidu is the “Google of China” and is a strong technological backbone in the region. The company is poised to benefit from a rebound in ad spend, cloud growth and even self-driving cars in the coming years. The company is inherently undervalued and relative to historical multiples at the time of writing and could therefore be a great long-term buy.