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Should Baidu Still Belong to China's BAT Tech Triumvirate?

By Leo Sun - Oct 29, 2019 at 8:30AM

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Or should it step aside and cede its spot to ByteDance?

China's BAT triumvirate consists of Baidu ( BIDU 7.47% ), Alibaba ( BABA 10.40% ), and Tencent ( TCEHY 2.98% ). Baidu owns China's top search engine, Alibaba is its top e-commerce and cloud player, and Tencent dominates the country's mobile messaging and gaming markets.

Those three companies have dominated conversations of China's tech industry. But over the past 12 months, Baidu shed nearly half its market value as Alibaba and Tencent both rallied more than 20%.

A Chinese flag superimposed on a circuit board.

Image source: Getty Images.

That drop reduced Baidu's market cap to about $36 billion, making it smaller than companies like e-commerce underdog Pinduoduo, which is worth about $47 billion, and the start-up ByteDance, which was valued at $78 billion last year.

Baidu's decline raises a troubling question: Should investors still consider the BAT companies to be the core of China's tech market? Or should we scrap the acronym and stop calling Baidu a top Chinese tech stock?

What went wrong for Baidu

Baidu's growth slowed to a crawl over the past year due to three main headwinds. First, the economic slowdown in China, which was exacerbated by the trade war, caused companies to cut their ad purchases. As a result, Baidu's online marketing revenue -- which accounted for 73% of its top line last quarter -- hit a brick wall.

Year-over-year growth

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Online marketing revenue

25%

18%

10%

3%

(9%)

Source: Baidu quarterly reports.

Second, Baidu faced tougher competition in the shrinking ad market from rivals like Tencent's WeChat, the top mobile messaging platform in China with 1.13 billion monthly active users (MAUs), and ByteDance's TikTok, the popular short video app, which surpassed 500 million worldwide MAUs last year. ByteDance's news aggregator app Toutiao also reaches over 120 million daily active users (DAUs).

Lastly, Baidu's main search engine faces challenges from internal search engines in WeChat, Toutiao, and other apps; Alibaba's ( BABA 10.40% ) Shenma mobile search engine; and Sogou's voice search feature for its popular mobile keyboard app.

An online search box superimposed on a photo of laptop keyboard.

Image source: Getty Images.

WeChat and other apps are integrating various services, like food deliveries, ride-hailing apps, and payments, into their apps with "mini programs" that run within their own apps. Those moves corral users into walled gardens, and arguably dilute Baidu's relevance.

Baidu is striking back by selling smart speakers, expanding its mobile app (which still has over 200 million DAUs) with its own mini programs, and investing in next-gen markets like AI and driverless cars, but that ecosystem expansion is weighing down its margins.

Baidu is also offsetting the slowdown of its core advertising business with the growth of its streaming video platform iQiyi ( IQ 5.95% ), but that subsidiary remains unprofitable and a dead weight on Baidu's bottom line. Analysts expect all those headwinds to reduce Baidu's revenue and earnings by 1% and 55%, respectively, this year.

Why ByteDance could replace Baidu in the BAT stocks

As Baidu struggles to evolve is business, ByteDance -- which was founded just seven years ago -- is flourishing. Back in July ByteDance stated that it had 1.5 billion MAUs and 700 million DAUs across all its platforms, which include TikTok, Toutiao, its mobile messaging app Flipchat, the video chat service Duoshan, the enterprise collaboration platform Lark, and other apps.

Many of ByteDance's apps, particularly TikTok and Toutiao, are popular with China's Gen Z users. ByteDance is capitalizing on that popularity by launching mini programs for TikTok in China and its own branded Android smartphone with pre-installed apps.

TikTok (known as Douyin in China) is also the first Chinese mobile app to gain a massive global audience. That's why it was the most downloaded non-game iOS app in the world last year, according to Sensor Tower. By comparison, most of Baidu's attempts to expand overseas flopped due to tough competition from Alphabet's Google.

ByteDance reportedly generated $7.2 billion in revenue in 2018, and it expects to more than double that figure to 120 billion yuan ($17 billion) this year, which would nearly match Baidu's projected revenue of $17.1 billion. ByteDance also expects to turn profitable in the second half of this year.

Those facts all strongly indicate that ByteDance, which is reportedly gearing up for an IPO in the near future, could take Baidu's place alongside Alibaba and Tencent in a new BAT triumvirate.

But should investors give up on Baidu?

Baidu belongs in the penalty box for now, but investors should still recall its strengths. Its ad business should rebound if a trade deal is reached, and its ecosystem is still expanding with its DuerOS virtual assistant, smart speakers, connected cars, and mini programs. It's also streamlining its business by cutting costs and divesting non-core businesses.

Therefore, it's still premature to call Baidu an also-ran in China's tech race. However, I think investors can replace Baidu with ByteDance in discussions about China's BAT companies -- at least until the wounded search giant shows some flickers of life.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Baidu, Inc. Stock Quote
Baidu, Inc.
BIDU
$147.65 (7.47%) $10.26
Tencent Holdings Limited Stock Quote
Tencent Holdings Limited
TCEHY
$58.45 (2.98%) $1.69
Alibaba Group Holding Limited Stock Quote
Alibaba Group Holding Limited
BABA
$123.60 (10.40%) $11.64
iQIYI, Inc. Stock Quote
iQIYI, Inc.
IQ
$4.99 (5.95%) $0.28

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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