Image source: Baidu.
This would seem to be a good time to bet against Baidu (BIDU 0.57%). Growth is slowing at China's leading search engine, a natural deceleration that is being made worse by restrictions on how it presents once-lucrative medical ads. Baidu has offered up uninspiring guidance not once but twice this summer. Margins continue to be pressured as the dot-com giant diversifies into new areas. Plans to unload its deficit-saddled video streaming business, a move that would've scored Baidu a gross payday north of $2 billion, fell apart last month.
The red flags seem to be everywhere, and these are the developments that naysayers live for. You would think that short interest would be going through the roof at Baidu, but it's actually going the other way around.
| Date | Short Interest |
|---|---|
| June 15, 2016 | 9.1 million |
| June 30, 2016 | 6.8 million |
| July 15, 2016 | 6.5 million |
| July 29, 2016 | 4.8 million |
Data source: Nasdaq.
Climbing the Great Wall of Worry
Baidu is coming off what even by its own admission was a "tough" quarter. Adjusted earnings plunged 30% since the prior year's showing. Revenue climbed by just 10%, or 16% if you account for the de-consolidation of its Qunar (QUNR +0.00%) online travel business. It's Baidu's worst quarter of growth as a public company, and it's going to get worse.
Its guidance for the current quarter calls for $2.714 billion to $2.796 billion in revenue. If factoring out the Qunar transaction, we're eyeing organic top-line growth of just 5.4% to 8.6% since the prior year. So, yes, the record set in the second quarter for its weakest period of growth will be short-lived.
Baidu has now come through with four quarters in a row of declining earnings. We're now nearly waist-deep into the quarter that will inevitably stretch this streak to five. It's been 10 trading days since what may have seemed like a train wreck of a quarter, but the stock has managed to claw its way back to trade slightly above where it was the day it would go on to post its second-quarter results.
Dark clouds may be everywhere, but why are so few worrywarts packing umbrellas? The logical explanation is that the market's discounting the near-term hiccups. The slowdown in revenue growth is largely explained by regulators requiring search engines to scale back on how health-related ads are presented following a widely publicized death of a patient that sought treatment at a questionable cancer center that he found through Baidu. The ramifications are real and likely permanent, but the comparisons will get better by the springtime of next year.
It was disappointing to see negotiations break down on the potential sale of its iQiyi video hub, but if one activist is right, it will be worth a lot more as a continuing business for Baidu or in a future sale. The red flags are there, but the crimson starts to fade when you consider the positive side effects of all of the negative developments. The short-sellers on the way out may know what they're doing after all.
