Baidu Inc. (BIDU, Financial) is the world’s eighth largest internet company based on revenue of $13.5 billion during the last 12 months. The stock is down 10% on the year, after a few 20% swings in both directions. Yet, with the company set to book major increases in revenue and earnings during 2018 and 2019, it’s time to buy.
Baidu is also the largest search engine in China, a country that U.S. firms will find it very hard to break into, regardless of the outcome from the current trade war. Like Google, its U.S. competitor, Baidu generates most of its profit from online marketing (86%) and uses the cash flow to invest in new technologies like a artificial intelligence and autonomous cars.
In fact, it’s evolving from a mobile-first to an artificial-intelligence-first company and is thought to be the technology leader within China, which has almost four times the population of America, and could have close to one billion people connected to the Internet by 2020. In the near term, margins will remain around 50% (historically they were 10-20% higher) due to aggressive content spending and talent acquisition costs for AI personnel. However, if it continues to grow sales at 24% quarter over quarter, profits will still outpace capital spending.
Baidu is seeing very strong customer and revenue growth from the video business, iQiyi, and while content costs widened the loss for iQiyi, management is forecasting high content spend over the next few quarters to capture attention. A little known fact.
From a financial standpoint, YouTube is a massive loser for Alphabet, but the attention it garners makes it worth the loss. The same thing is true for Baidu, which could subject users to either a pay model or more advertising to eventually drive profit, but for now, attention is the game. IQiyi (IQ), Baidu’s online video platform, has been a key driver of top-line growth since 2015, and has a market cap north of $20 billion. Baidu still retains majority ownership of the company, and now has two ways to raise money to grow the business.
Search is still wildly profitable for the company and it's set to earn $20 a share over the next two years. And the appetite for internet and mobile content is just getting started. With more content consumption comes more advertising money at higher bid rates per placement. In other words, more people looking and clicking means more marketing dollars chasing and paying more to acquire customers -- all good news for Baidu.
From a valuation standpoint, investors should take advantage of this price as it represents lower multiples than historical averages in a company still growing like Google (now Alphabet) in 2008. If it earns above $10 a share in 2019, and trades with the same multiple as Alphabet (33x) the stock would be $330 a share. That’s well within its potential. In fact, considering that Alphabet is priced 11x higher than Baidu, but only generates 4.25x more profits, Baidu should be good for a double in the next three to five years.
Longer term, everyone is looking at Baidu’s potential in AI-based apps or services, including autonomous driving. It has roughly 400 million monthly active users to its site with more on the way, all of which will likely be testing new apps at some point.
Baidu has plenty of cash to keep investing in this area and if just one breakthrough scales, the value of the stock could scale right along with it. The biggest risk is losing attention of the consumer. As long as internet users want to search for things, Baidu should be the place they turn first. And now, with the trade war heating up, China is not going to allow American competition to take away from its own country's top technology company.
Disclosure: I am not long/short any stock mentioned in this article.
