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Is Baidu's Stock Finally Ready to Rebound?

By Leo Sun – May 20, 2020 at 2:09PM

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First-quarter earnings suggest the Chinese search giant remains a work in progress.

Baidu's (BIDU -0.53%) stock popped after the Chinese tech giant posted its first-quarter earnings on Monday. Its revenue declined 7% annually to 22.5 billion yuan ($3.2 billion) but beat expectations by $90 million.

Its adjusted net income jumped 219% to 3.1 billion yuan ($435 million), or $1.25 per ADS -- which crushed expectations by $0.69. Its adjusted EBITDA, which excluded certain one-time gains and losses, rose 61% to 2.9 billion yuan ($403 million).

Baidu expects between a 5% loss and a 4% gain in annual revenue growth in the second quarter. That's a broad range, but it suggests the company passed a cyclical trough in the first quarter. Its profit growth also suggests its dependence on iQiyi (IQ 1.04%) isn't denting its margins.

Do those improvements indicate it's finally safe to buy Baidu's stock, which tumbled 40% over the past three years due to tough competition in online ads, a slowdown in the Chinese economy, an escalating trade war, and the COVID-19 crisis?

Stock prices displayed on an outdoor digital screen on the street

Image source: Getty Images.

Did Baidu address its biggest problems?

Baidu generated 63% of its revenue from its online ads during the quarter, down from 73% a year ago. The rest of its revenue came from its "other" businesses -- which include iQiyi, Baidu Cloud, and its smart speaker business. iQiyi generated 92% of that segment's revenue.

A search box superimposed over a photo of someone typing on a laptop

Image source: Getty Images.

Baidu faces three main headwinds. First, its search-based online ads face intense competition from rivals such as Tencent's (TCEHY -2.08%) WeChat, Alibaba's (BABA -1.55%) marketplaces, and ByteDance's Gen Z-oriented TikTok and Toutiao apps. The slowdown in the Chinese economy is also throttling ad spending across multiple industries.

Second, Baidu's dependence on iQiyi is a double-edged sword. The streaming video platform is growing at a faster clip than its core advertising business, but it's unprofitable and faces stiff competition from Tencent Video and Alibaba's Youku Tudou. It was also recently hit by allegations of fraud from prolific short-sellers.

Lastly, many of Baidu's ecosystem-expanding efforts -- including its cloud, AI, Mini Program, and driverless platforms -- aren't generating meaningful revenue yet. Instead, Baidu is incurring losses on these projects to widen its moat against Tencent, Alibaba, and other Chinese tech giants.

That's why Baidu's revenue fell in the first quarter: iQiyi's growth failed to offset its declining ad revenue, and its newer businesses failed to pick up the slack:

Growth (YOY)

Q1 2019

Q2 2019

Q3 2019

Q4 2019

Q1 2020

Online marketing

3%

(9%)

(9%)

(2%)

(19%)

Other

73%

44%

34%

35%

28%

Total revenue

15%

1%

0%

6%

(7%)

Adjusted net income

(80%)

(53%)

(35%)

95%

219%

Data source: Baidu quarterly reports. YOY = year over year. 

But why are Baidu's earnings rising?

Baidu's growing dependence on iQiyi's unprofitable platform and its investments in next-gen technologies throttled its earnings growth throughout most of 2019. Yet its earnings growth turned positive and accelerated for three reasons: It faced easier year-over-year comparisons, it repurchased shares, and it reduced the traffic acquisition costs (TAC) at its advertising business.

Baidu generally doesn't spend as much TAC as its smaller search rivals to acquire traffic, but that lower spending could still leave it more vulnerable to smaller search rivals like Sogou (SOGO), as well as ad giants like Tencent, ByteDance, and Alibaba.

Tencent, for example, grew its online ad revenue 32% annually during the first quarter as lockdown-focused businesses across the gaming, internet services, and online education industries purchased more ads on WeChat Moments.

Baidu's failure to capitalize on those trends highlights a dilemma: It can either boost its TAC to confront the competition, thus throttling its earnings growth, or it can reduce its TAC to offset the margin pressure from iQiyi and other lower-margin businesses to protect its bottom line. 

What does Baidu expect from the second quarter?

Baidu's mobile app grew its daily active users 28% annually to 222 million in March. Its in-app search queries rose 45% as time spent on its feeds climbed 51%.

Baidu believes that corralling users into the app, which also offers Mini Programs such as WeChat, can widen its moat against Tencent. However, WeChat still serves a larger audience, and Baidu's expansion of its mobile app ecosystem isn't significantly boosting its ad revenue yet.

During the conference call, CEO Robin Li stated: "With the pandemic coming under control in China, offline activities are rebounding, and Baidu stands to benefit from a restart of the Chinese economy." Li believes that macro recovery will strengthen its ad business as it expands its mobile app and narrows the losses at its cloud and AI businesses.

However, it's unclear if iQiyi's losses -- which widened significantly in the first quarter -- will narrow anytime soon. That's probably why Baidu didn't offer any bottom-line guidance for the second quarter. For now, analysts expect its revenue to rise 3% for the year, but for its earnings to drop 14%.

Is Baidu ready to rebound?

Baidu's profit growth is encouraging, but it needs to generate meaningful revenue growth with stable margins to be considered a viable investment again. I'm still bullish on Baidu's long-term prospects, but it remains a work in progress that won't revisit its all-time highs anytime soon.

Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Alibaba Group Holding Ltd., Baidu, and Tencent Holdings. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Baidu, Inc. Stock Quote
Baidu, Inc.
BIDU
$118.84 (-0.53%) $0.63
Tencent Holdings Limited Stock Quote
Tencent Holdings Limited
TCEHY
$35.25 (-2.08%) $0.75
Alibaba Group Holding Limited Stock Quote
Alibaba Group Holding Limited
BABA
$77.69 (-1.55%) $-1.22
Sogou Inc. Stock Quote
Sogou Inc.
SOGO
iQIYI, Inc. Stock Quote
iQIYI, Inc.
IQ
$2.91 (1.04%) $0.03

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