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The 4 Biggest Risks Facing Baidu's Stock

By Leo Sun - Feb 8, 2020 at 9:56AM

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The Cyberspace Administration of China is just one potential source of headaches for China’s top search engine.

Baidu's (BIDU -3.11%) stock recently rallied after the Chinese tech giant raised its fourth-quarter guidance ahead of its full earnings report on Feb. 27. It now expects its revenue to rise 5.1% annually at the midpoint, compared to its prior forecast for 2.6% growth.

It expects revenue from its core businesses, which exclude entertainment platform iQiyi (NASDAQ: IQ) and other non-core businesses, to grow 4%-6%, compared to a previous forecast for 0%-6% growth. It also expects the midpoint of its non-GAAP net income to nearly double.

Those numbers sent analysts scrambling to revise their estimates, and indicated that Baidu's struggling ad business was improving and that its stock was finally bottoming out. But before investors load up on Baidu's stock, they should review the four biggest threats to its long-term growth.

Bags labeled risk and reward balanced on a beam.

Image source: Getty Images.

1. Tencent's WeChat

Tencent's WeChat, which hit 1.15 billion monthly active users (MAUs) last quarter, is the most popular messaging app in China. It added mini programs -- which let users access online marketplaces, ride-hailing platforms, and other services without leaving the app -- in early 2017.

The platform's total number of mini programs exceeded 1 million in 2018. Last quarter, Tencent stated that its total number of daily active users (DAUs) on mini programs grew 45% annually to 300 million.

WeChat provides its own internal search engine for finding content across its platform. It also integrates Sogou (NYSE: SOGO), the second-largest search engine in China after Baidu, into WeChat for external searches.

Baidu is fighting back by launching mini programs for its own mobile app, but that ecosystem still reaches fewer users than WeChat. If Tencent locks more users into WeChat's walled garden, Baidu's core search engine could lose its clout with internet users and advertisers.

2. ByteDance's TikTok and Toutiao

Beijing-based ByteDance replaced Baidu as the second-largest digital advertising platform in China after Alibaba (NYSE: BABA) last year, according to research firm R3.

ByteDance's entire family of apps reaches over 1.5 billion MAUs. Its meteoric growth was mainly fueled by two of those apps: the short video app Douyin (known as TikTok overseas), and Jinri Toutiao, a news app that aggregates clickable articles.

Douyin locks in Gen Z users with its short musical videos, and its total monthly active users (MAUs) -- including TikTok -- topped 500 million in 2018. Toutiao mainly appeals to younger and lower income users across China with its short articles.

ByteDance launched an internal search engine, which lets users scour older articles and content, for Toutiao last year. This was a clear shot at Baidu, and indicated that ByteDance was following Tencent's "walled garden" strategy of locking users into its ecosystem. Baidu is fighting back against ByteDance with its news app and its short video app Haokan, but neither effort has throttled ByteDance's growth yet.

3. Alibaba's sprawling ecosystem

Baidu surpassed Alibaba as China's top smart-speaker maker last year, but it did so by selling its speakers at rock-bottom prices. If Alibaba retaliates with even cheaper speakers, a margin-crushing price war could erupt between the tech giants.

A couple uses a smart speaker at home.

Image source: Getty Images.

But that's not all. Alibaba also owns Shenma, the second-largest mobile search engine in China. Alibaba already integrates some of its e-commerce search results into Shenma, and stronger ties with Taobao and Tmall could help its search engine gain ground against Baidu.

Alibaba also owns the largest cloud infrastructure platform in China. It controls nearly half of that high-growth market, according to Canalys, while Baidu ranks fourth with an 8% share. Baidu is trying to stay afloat in this competitive market, but it could struggle to pull customers away from Alibaba Cloud and other rivals without aggressive promotions.

4. The Chinese government

Lastly, the Chinese government frequently throttles Baidu's growth with overbearing regulations. Back in 2016, a cancer-stricken student died after trying an experimental treatment advertised on Baidu. In response, Chinese regulators forced Baidu to curb its sales of healthcare ads -- which accounted for 20%-30% of its revenue at the time.

The government has also tightened its regulations on the fintech and video game markets over the past two years, which caused Baidu's ad revenue from those two high-growth markets to plummet. The Cyberspace Administration also temporarily suspended some of Baidu's news services in early 2019 as part of a six-month crackdown on "vulgar" content.

The unpredictable nature of those crackdowns is a volatile headwind for Baidu, and it forces the search giant to hire more censors and tighten up its own algorithms. In other words, the government's actions could dent Baidu's revenue growth and cause its operating expenses to rise.

The bottom line

I own shares of Baidu, and I think its updated guidance indicates that the headwinds which battered the stock over the past year are finally waning. However, I'm still keeping a close eye on these four long-term challenges, since they could derail the tech giant's fragile recovery.

Leo Sun owns shares of Baidu. The Motley Fool owns shares of and recommends Baidu. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.

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