Longtime investors in Alphabet Inc. (NASDAQ:GOOGL) (NASDAQ:GOOG) will recall that in early 2010, online search giant Google discontinued its operations in China as the result of large-scale hacks that originated from within the country and continuing issues with government censorship. Google decided to pull the censored search portal, Google.cn, and rerouted the traffic to servers in Hong Kong. This decision left Chinese search leader Baidu, Inc. (NASDAQ:BIDU) with a near-monopoly, and it has dominated the search landscape in China ever since.
A recent report revealed that the United States government is considering curbing Chinese investments in Silicon Valley, particularly in the fields of artificial intelligence (AI) and its subdiscipline machine learning. Fearing that these technologies could be used in military applications, and citing national security, the U.S. is seeking to increase oversight by the Committee on Foreign Investment in the United States (CFIUS). The panel, which is made up of the department heads from Treasury, Commerce, Justice, Defense, and Homeland Security, is charged with reviewing the acquisition of U.S. companies by foreign entities.
In an extreme bit of irony, the company positioned to suffer the most from this oversight is Baidu.
AI is driving this train
Baidu is one of a number of companies betting big on the future of AI. This quote from the company's April 2017 earnings announcement illustrates how serious the company is about the subject: "As we move into 2017, Baidu's strategic evolution from a mobile-first to an AI-first company continues to gain momentum," stated Robin Li, Baidu's chairman and CEO.
Baidu has been struggling with falling revenue related to a cleanup of advertisers on its signature search, seeing the third consecutive quarter of such declines. Its revenue of $2.45 billion increased 6.8% year over year, while earnings fell 10.6% compared to the prior-year quarter.
What goes around comes around
Baidu has been increasingly betting that AI is the company's ticket to renewed growth. Baidu began work in the field of AI more than five years ago, initially in the area of deep learning. By developing a software model and algorithms that mimic the structure and function of the human brain, the software learns to recognize patterns. These developments have led to advancements in image recognition and language processing, and sowed the seeds for autonomous driving.
In April 2017, Baidu acquired xPerception, a U.S. AI start-up that developed computer-vision technology in a bid to advance its autonomous-driving aspirations. A report from the Pentagon that has yet to be released indicates that deals such as joint ventures, start-ups, and minority stakes have not historically triggered oversight by CFIUS; officials are concerned that China is gaining access to sensitive technology via these unmonitored transactions. Baidu's acquisition of xPerception may be perceived as falling into that category. If the U.S. follows through with its intentions, future deals could be blocked, hampering Baidu's future AI aspirations.
Don't cry too many tears for Baidu, though. In February 2017, the Chinese government charged Baidu with task of establishing a national laboratory of deep learning. This loose construct will be composed of a network of academics and researchers sharing data. Tsinghua and Beihang Universities and members of the Chinese Academy of Sciences will join Baidu in the effort, which will initially focus on computer vision, human-computer interaction and biometric identification. The Chinese government will fund the effort, though the amount was not disclosed. Any setbacks Baidu suffers as a result of the U.S. decision will likely be made up at home.
In the grand scheme of things, this move won't have any lasting effect on Baidu's long-term AI aspirations. The company has independently developed the majority of its AI technology, and that trend is sure to continue. It has parlayed its early efforts into the lead in China, and hopes that it can remain among the world's elite in AI technology.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Alphabet (A shares) and Baidu. Danny Vena has the following options: long January 2018 $640 calls on Alphabet (C shares) and short January 2018 $650 calls on Alphabet (C shares). The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Baidu. The Motley Fool has a disclosure policy.