Shares of Baidu (NASDAQ:BIDU) recently popped after the Chinese tech giant posted its third-quarter numbers. Its revenue stayed flat year-over-year at 28.1 billion yuan ($3.93), but beat estimates by $40 million. Excluding its upcoming divestments of several non-core businesses, its revenue rose 3%.

Baidu's non-GAAP net income fell 35% to 4.4 billion yuan ($614 million), or $1.76 per ADS, but still beat expectations by $0.60. On a GAAP basis, which excludes its stock-based compensation expenses and impairment charges, it posted a net loss of 6.4 billion yuan ($892 million), compared to a profit from 12.4 billion yuan a year ago. Those growth rates look dismal, but a closer look indicates that Baidu's ongoing declines are finally bottoming out.

Gold figures of a bear and a bull on a newspaper.

Image source: Getty images.

Sequential growth in advertising revenue

Baidu's advertising revenue, which accounted for 73% of its top line during the quarter, fell 9% annually and marked the unit's second straight quarter of declining revenue:

Year-over-year growth

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Online marketing revenue

18%

10%

3%

(9%)

(9%)

Source: Baidu quarterly reports.

However, it also marked its second straight quarter of sequential growth. On a quarter-over-quarter basis, Baidu's ad revenue grew 9% in the second quarter and 6% in the third quarter.

Baidu's traffic acquisition costs (TAC) rose 5% annually to 3.2 billion yuan ($453 million), but accounted for less than 16% of its total ad revenue -- compared to 18% in the first and second quarters. This indicates that as China's top search engine, Baidu isn't spending much cash to acquire new traffic.

By comparison, Alphabet's Google spent 22% of its ad revenue on TAC last quarter. Sogou , which ranks a distant second in China's search market, spent a whopping 46% of its revenue on TAC last quarter.

Baidu's number of marketing customers fell 4% annually but grew 5% sequentially to 330,000. It noted that ad sales remained soft in the healthcare, gaming, financial services, and auto logistics markets. Baidu has notably been cautious about selling healthcare ads since a government crackdown on misleading medical ads in 2016, and the gaming and fintech markets were both likely affected by tighter government regulations.

The ongoing trade war, the slowdown in the Chinese economy, and competition from rival platforms like Tencent's  WeChat and ByteDance's TikTok exacerbated that pain. Nonetheless, the sequential growth of Baidu's advertising business and its low TAC ratio indicate that it isn't struggling to stay relevant.

A floating online search box and a man using a laptop.

Image source: Getty Images.

Still dependent on iQiyi's growth

Once again, the growth of Baidu's video streaming unit iQiyi (NASDAQ:IQ) offset the weakness of its core advertising business. iQiyi's total revenue rose 7% annually to 7.4 billion yuan ($1.04 billion), or 26% of Baidu's top line. Its higher-margin subscription revenue rose 30% annually, but that growth was mostly offset by 14% drop in its lower-margin advertising revenue from free viewers.

iQiyi's content costs rose just 3%, but the company -- which went public last year -- remains deeply unprofitable. In short, iQiyi props up Baidu's revenue growth but throttles its bottom line growth -- which is an unsustainable long-term strategy.

Its ecosystem is still expanding

Baidu continues to widen its moat against Tencent's WeChat, which integrates over a million "mini programs" into its market-leading messaging app, by locking users into its own mobile app with similar mini programs. The number of average daily active users (DAUs) on Baidu's mobile app rose 25% annually to 189 million in September, while monthly active users (MAUs) for the app's mini programs surged 157% to 290 million.

Baidu also continues to lead China's smart speaker market with its DuerOS-powered devices. Monthly voice queries on DuerOS, which closely resembles Amazon's Alexa, more than quadrupled year-over-year to 4.2 billion. Voice queries on Baidu Maps also doubled.

Baidu's driverless unit also continues to expand with 150 autonomous driving licenses across Chinese cities and the launch of its first driverless taxi pilot program in Changsha, Hunan. All these moves will help Baidu gradually expand its ecosystem beyond its core search engine.

The road ahead

Baidu expects its revenue to rise nearly 3% annually (at the midpoint) in the fourth quarter, which indicates that its core advertising engine is warming up again. Its earnings growth will likely remain messy due to its divestments and investments, but those efforts could streamline its business and counter aggressive rivals like Tencent.

Baidu still has a lot of work to do, but the stock remains historically cheap at 17 times forward earnings. It probably won't recover its year-to-date losses anytime soon, but gradual improvements to its core business could bring back the bulls.