Baidu (BIDU 0.39%) has had a rough year so far due to escalating trade tensions, a weakening RMB, and rising interest rates, which have led investors to shun Chinese growth stocks. However, the Chinese tech giant recently assuaged some of those fears with a solid top and bottom line beat for the third quarter.
Baidu's revenue rose 27% annually to 28.2 billion RMB ($4.11 billion) during the quarter, clearing estimates by $40 million. Revenues from its central "Baidu Core" business -- which exclude revenues from iQiyi (IQ -1.45%) and other smaller businesses -- grew 25% to 21.6 billion RMB ($3.15 billion).
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On the bottom line, Baidu's non-GAAP net income rose 47% annually to 6.7 billion RMB ($973 million), or 19 RMB ($2.77) per ADS, which beat expectations by $0.32. Baidu Core's non-GAAP net income rose 57% to 8.4 billion RMB ($1.22 billion).
For the fourth quarter, Baidu expects its revenue to rise 15% to 20% (in RMB terms) year-over-year, which seemingly missed the consensus forecast for about 22% growth. But excluding the revenues from several divestments -- most notably its Du Xiaoman financial services unit -- Baidu expects its revenue to rise 20% to 26% during the fourth quarter, which matches analyst expectations.
Baidu's growth looks solid relative to its forward P/E of 16, but investors are probably still wary of buying Chinese tech stocks in a volatile market. Let's dig deeper into Baidu's numbers to see if the rewards outweigh the risks.
Breaking down the core numbers
Baidu's online marketing revenue rose 18% annually and accounted for 80% of its top line. Its number of active online marketing customers grew 7% to 522,000, and its revenue per online marketing customer increased 12% to 43,100 RMB ($6,300).
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Baidu's traffic acquisition cost (TAC) rose 25% to 3.1 billion RMB ($450 million), and accounted for 11% of its revenue compared to 10% in the second quarter and 11% in the first quarter. That stability indicates that Baidu doesn't need to spend much money to lock in advertisers.
The Baidu App's daily active users (DAUs) rose 19% annually to 151 million in September, and over 100 million monthly active users (MAUs) used the app's new Smart Mini Programs in September. Baidu also revealed that DuerOS, its Alexa-like virtual assistant for smart speakers and other devices, had an installed base of 141 million in September, up from 100 million in July.
Baidu's revenue from iQiyi, which it spun off in an IPO earlier this year, rose 48% to 6.9 billion RMB ($1.01 billion). That growth was mainly attributed to its growth in subscribers, which rose by 13.5 million during the quarter to 80.7 million. Baidu retains a majority stake in iQiyi, but changing it from a subsidiary to an investment reduced some of the pressure on its bottom line.
Margins remain under pressure
Like many of its industry rivals, Baidu is investing heavily in the expansion of its ecosystem into next-gen markets like smart homes, connected cars, artificial intelligence, and cloud services. It also still spends cash on content acquisition costs for iQiyi and its own content creation platform BJH.
As a result, Baidu's non-GAAP operating margin fell five percentage points annually to 20%. However, Baidu Core's non-GAAP operating margin stayed roughly flat at 37%.
The bears believe that as Baidu's ecosystem war against Tencent, Alibaba, and other companies heat up, those margins will remain under pressure as the battles spill over to adjacent markets with loss-leading strategies. However, the bulls believe that Baidu can leverage its dominance of China's online search market to hold those rivals at bay.
Still a solid long-term investment
Baidu remains one of the safest plays on China's growing internet sector, and its 20% decline this year makes it an undervalued growth stock. Baidu still faces plenty of near-term headwinds, but the stock could rebound sharply on any positive news regarding a potential trade deal between the U.S. and China. Investors who are willing to ride out this near-term volatility should be well-rewarded over the long term.
