Like most equity issues from the Middle Kingdom, Chinese search leader Baidu (NASDAQ:BIDU) has traded downward recently, losing more than a third of its value as the escalating trade tensions and tit-for-tat tariffs between the U.S. and China create a growing sense that a protracted battle could dent the economies of both nations.

When Baidu reported its third quarter results, investors were hoping the results would be sufficient to put those fears to rest. There was plenty to like, but a weaker forecast for the fourth quarter fed fears of slowing growth in China, giving investors reason for pause. 

Baidu's Silicon Valley AI Lab.

Image source: Baidu.

Topping expectations

Metric

Q3 2018

Q3 2017

YOY Change

Net revenue

$4.11 billion

$3.53 billion

27%

Operating income

$645 million

$706 million

(6%)

Adjusted earnings per share

$2.77

$1.90

46%

Data source: Baidu's Third-Quarter Financial Report. Differences due to exchange rates. YOY=Year Over Year.

Baidu reported revenue of 28.2 billion yuan, or $4.11 billion, up 27% year over year, exceeding analysts' consensus estimates and coming in at the midpoint of the company's forecast. Adjusted earnings per share of 19 yuan, or $2.77, grew 46% year over year, and topped analysts' expectations of $2.40 per share. 

Online advertising continues to provide the lion's share of Baidu's sales, producing revenue of $3.27 billion, up 18% year over year. Online marketing customers climbed to 522,000, up 7% compared with the prior-year quarter. Existing customers continue to spend more, with revenue per online marketing customer growing to $6,300, a 12% increase from the year-ago quarter.

Baidu's core search business generated $3.15 billion of its revenue, up 25% year over year, while the company's video-streaming service iQiyi (NASDAQ:IQ) added just over $1 billion, an increase of 48% compared with the prior-year quarter.

Content costs grew to $981 billion, up 73% year over year, due primarily to iQiyi's seemingly insatiable appetite for new programming and to a lesser extent for content to populate Baidu's news and entertainment feed.

Traffic acquisition costs topped $450 million, up 25% year over year, while bandwidth costs of $247 million grew 18% compared with the prior-year quarter.

Selling, general, and administrative costs grew to $821 million, up 51% year over year, as Baidu increased its investment in channel and promotional marketing. Research and development expenses of $570 million climbed 21% compared with the prior-year quarter, as the company added additional engineers, largely related to its continuing pursuit of artificial intelligence (AI) solutions.

More than just financial

Baidu became the first Chinese company to join the Partnership on AI, an industry consortium that helps establish best practices and advance the public understanding of AI.

The company continued its focus on numerous AI initiatives as it plants the seeds for future growth. DuerOS, Baidu's voice-controlled digital assistant, crested an installed base of 141 million devices, up from just 100 million three months ago. Voice queries on the platform topped 800 million, doubling sequentially compared with last quarter. The DuerOS skills store has grown to over 800 skills, and Baidu's Xiaodu Smart Speaker was rated the most intelligent smart speaker by the China Artificial Intelligence Industry Alliance.

Baidu's Apollo open-source self-driving platform now boasts 130 OEM, Tier 1 parts suppliers, and other partners.

Cloud computing is another area of focus for Baidu, and the company announced that its ABC Cloud was the fastest-growing cloud service provider in China, and among the top three most technologically advanced. 

Women in traditional Chinese dress in a scene from iQiyi original "Story of Yanxi Palace."

A scene from the iQiyi original Story of Yanxi Palace. Image source: iQiyi.

The most dynamic growth was produced by iQiyi, Baidu's streaming service that went public earlier this year. The company added 13.5 million new subscribers to the platform, a new quarterly record, driving total subscribers to 80.7 million. Baidu said that iQiyi ranked No. 1 across reach and engagement metrics in Q3 2018, according to third-party market research firms. A strong showing by iQiyi original Story of Yanxi Palace helped drive the results, garnering more than 20 billion total video views for the series.

What the future holds

For the upcoming fourth quarter, Baidu is forecasting revenue in a range of 25.48 billion yuan and 26.72 billion yuan, or between $3.71 billion and $3.89 billion at current exchange rates, which would represent growth of between 15% and 20% year over year. Baidu pointed out that previously divested businesses added more than 1 billion yuan in each of the first three quarters, and since these transactions have been completed, those businesses would have no impact on the fourth quarter.

The guidance fell short of analysts' consensus estimates, which were calling for $3.98 billion and earnings per share of $2.43.

While the market seems focused on the potential for long and protracted trade tensions, Baidu does all of its business in China, so the company has nothing to fear from tariffs. The company delivered on all the metrics that mattered, and its growth continues unabated.

 

Danny Vena owns shares of Baidu and iQiyi. The Motley Fool owns shares of and recommends Baidu. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.