Baidu Is Still Investing Heavily for Future Growth

Several quarters of decelerating growth have investors spooked, but Baidu is spending now to ensure future success.

Danny Vena
Danny Vena
Mar 7, 2019 at 9:15PM
Technology and Telecom

After spending the first half of 2018 in investors' good graces, Baidu (NASDAQ:BIDU) has fallen out of favor yet again. As late as May of last year, China's internet search leader was clocking all-time highs but had lost more than 40% of its value going into its latest earnings report. What caused this perilous fall from grace? Two quarters of decelerating growth, fears regarding China's slowing economy, and the ongoing trade conflict between Washington, D.C. and Beijing conspired to knock Baidu back down to size.

Going into Baidu's fourth-quarter financial report, investors were hoping the company could post results that were strong enough to send the stock climbing again. While the performance for the quarter was better than expected, weak guidance for the coming quarter sent Baidu tumbling to fresh recent lows.

A building with the Baidu logo near the roof.

Image source: Baidu.

Growth is slowing

For the fourth quarter, Baidu reported total revenue of 27.2 billion yuan ($3.96 billion), up 22% year over year, or up 28% excluding noncore businesses the company has sold off. This exceeded the high end of Baidu's guidance, which topped out at 26.72 billion yuan. Unfortunately, it marked a continued deceleration that occurred in the previous two quarters when Baidu posted year-over-year revenue increases of 32% and 27%, respectively. 

Baidu's core search and advertising business grew to 20.5 billion yuan ($2.98 billion), up 14% year over year, decelerating from the 28% and 25% year-over-year growth in the second and third quarters. This rapid slowing of the company's flagship business is undoubtedly what has investors felling a bit skittish.

iQiyi (NASDAQ:IQ), the company's video streaming business, produced revenue of 7.0 billion yuan ($1.02 billion), up 55% year over year. The strong top-line growth was driven by a raft of new subscribers, up 72% year over year, and topping 87.4 million. Revenue from those customers grew 76% year over year, while advertising sales from its ad-supported free streaming option grew 9% compared to the prior-year quarter.

Check out the latest earnings call transcript for Baidu.

While costs are rising

Baidu's content costs, which were primarily the result of increased investment in iQiyi programming, grew to 7.3 billion yuan ($1.07 billion), up 96% year over year. iQiyi is following the Netflix playbook, investing heavily in original movies and television shows, which has supported the streaming service's rapid growth.

Traffic acquisition costs (TAC) for the search business increased to 3.4 billion yuan ($491 million), up 34% year over year, the result of higher TAC and online TV revenue. Bandwidth costs of 1.8 billion yuan grew 27% year over year, driven by higher demand for feed, video, and cloud.

Perhaps the most egregious example of costs growing faster than revenue is in the company's selling, general, and administrative expenses, which increased to 5.9 billion yuan ($659 million), up 64% compared to the year-ago quarter. Baidu said much of the increase was the result of channel and promotional marketing, and personnel costs. Research and development expenses grew to 4.5 billion yuan ($659 million), up 22% year over year as the company added personnel.

A Baidu Apollo self-driving car outfitted with a host of sensors on the roof.

Image source: Baidu.


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Investing now to produce growth later

There are a number of areas of the business where the company is investing heavily now to produce future growth. In addition to content expenses for iQiyi, Baidu is focusing on a number of artificial intelligence (AI) initiatives. The company is employing AI to better match users with video content and advertising across a number of native apps, as well as Baidu's feed. It also serves customers of Baidu's cloud computing business.

DuerOS, Baidu's voice-activated digital assistant, continues to expand its user base, topping 204 million to round out 2018, up from 141 million in September. This represents compound annual growth of more than 100% for the seventh consecutive quarter. The DuerOS skills store has released apps that cover more than 1,000 skills, and a growing number of smart devices are powered by DuerOS.

One of the most promising uses of Baidu's AI technology is Apollo, the company's self-driving car platform. The company debuted Apollo 3.5 at the Consumer Electronics show in Las Vegas in January. Baidu CEO Robin Li said on the conference call, "Apollo has garnered over 135 OEMs, Tier 1 parts suppliers, and other strategic partners to date." In addition, the platform has been licensed for testing in more than 50 provinces and municipalities in China, more than any other company.

What the future could hold

For the first quarter of 2019, Baidu is forecasting revenue in a range of 23.5 billion yuan ($3.42 billion) and 24.7 billion yuan ($3.60 billion), an increase of between 12% and 18% year over year, or 18% and 24% excluding the revenue from the company's announced divestitures. The noncore businesses Baidu sold off generated 1.1 billion yuan in the first quarter of 2018 and won't contribute to the upcoming quarter, accounting for much of the weaker-than-expected guidance.

The combination of decelerating growth and the ongoing trade war have held down Baidu's stock price. It's important to remember that Baidu has a history of successfully responding to such challenges, and there isn't any reason to think that this time will be any different.