Baidu's (BIDU 0.88%) stock price recently tumbled after the Chinese tech giant posted mixed second-quarter results; its revenue dropped 1% annually and missed expectations, and it disclosed that the U.S. Securities and Exchange Commission had launched a probe of its video-streaming subsidiary iQiyi (IQ 3.05%).
During the conference call, CEO Robin Li attributed the revenue slowdown to "temporary setbacks" in its online marketing business -- including a new wave of COVID-19 infections, "geopolitical tension," and "other phenomenon plaguing the economy." Li's other comments were similarly vague, and likely left investors with more questions than answers.
Here are four burning questions that Baidu's management failed to answer, and why investors should be concerned that it didn't address them.
1. Is Baidu still a top advertising platform?
Online marketing revenue, which accounted for 67% of Baidu's top line, fell 8% year over year in the second quarter -- its fifth consecutive drop.
Baidu still controls 70% of China's online search market, but internet users are spending more time on rival platforms like Tencent's (TCEHY 1.80%) WeChat, Bilibili's (BILI 3.96%) digital media platform, and ByteDance's Gen Z-oriented apps. Tencent and ByteDance already offer in-app searches, and Tencent is trying to buy Sogou (SOGO), operator of the second-largest search engine in China, to strengthen its external searches.
Those higher-growth platforms are luring advertisers away from Baidu. Tencent and Bilibiil's online advertising revenues rose 13% and 90% year-over-year, respectively, in their latest quarters. ByteDance's revenue reportedly surged 130% in the first quarter of 2020.
Baidu's leadership didn't seem too concerned about those competitors. When questioned about Tencent's potential merger with Sogou, Executive VP Dou Shen declared Baidu's "brand awareness" was "hard to duplicate" and that it would "keep doing well" in the search market. Baidu also highlighted the growth of its mobile app for businesses, Managed Pages, and its BJH content creation platform -- but those improvements didn't meaningfully boost its ad revenue.
Baidu needs to counter its competition, but management's dismissive attitude about them, and its eagerness to blame its problems on macro headwinds, raise red flags.
2. Is iQiyi becoming a liability?
Over the past year, Baidu relied heavily on iQiyi's growth to offset the slowdown of its core advertising business. But iQiyi isn't profitable, so its revenue growth actually weighs down Baidu's margins.
To offset that pressure, Baidu has reduced the traffic acquisition costs (TAC) at its main search engine. Reducing TAC makes sense if Baidu is comfortably leading in the advertising market, but spending less money at a time when it's losing ground to rivals could further weaken its position.
Yet Baidu continues to depend on iQiyi, which grew its revenue 4% annually during the quarter and accounted for 27% of the company's top line. Earlier this year, a prolific short-seller accused iQiyi of inflating its revenue by up to 44%. During the conference call, management admitted that the SEC was probing iQiyi's accounting practices.
Chief Financial Officer Herman Yu declared that Baidu had "zero tolerance for fraud" and had launched an internal audit into iQiyi and hired external advisors. He didn't directly comment on the developing situation but warned that the audits and probe could take "longer than normal" due to COVID-19. Editor's note: This paragraph has been corrected to note it was Yu who said this.
Those comments were balanced and diplomatic, but they didn't answer two key questions: Is iQiyi becoming a liability for Baidu? And should Baidu consider divesting its remaining stake in the company?
3. Is Baidu's cloud business profitable?
Baidu doesn't regularly disclose its cloud revenue, but it claimed the cloud unit generated 2 billion yuan ($290 million) in revenue in the second quarter -- up from 1.1 billion yuan ($159 million) in the fourth quarter of 2018.
That growth rate is impressive, but it remains a tiny player in China's public cloud market behind Alibaba (BABA 2.55%) and Tencent. Alibaba Cloud, the top player in the market, generated 12.2 billion yuan in revenue ($1.73 billion) last quarter -- and it's still unprofitable.
If Alibaba is operating its cloud business at a loss, it seems highly unlikely that Baidu's underdog cloud platform is generating any profits. Instead, it's likely another dead weight on its bottom line.
4. Will Baidu delist its stock from the Nasdaq?
Lastly, Baidu didn't offer investors any insight into what it sees as its future on U.S. stock exchanges. Earlier this year, the U.S. Senate passed a bill that could force Chinese companies to delist their U.S. shares if they didn't open their books and comply with new regulations. U.S. Treasury Secretary Steven Mnuchin recently warned those delistings could occur at the end of 2021.
Back in May, Robin Li ominously declared there were "many choices" for stock listings beyond U.S. equities markets. That same month, Alibaba CFO Maggie Wu reassured investors that the company had no plans to delist its U.S. shares, even as it launched a secondary IPO in Hong Kong.
The bottom line
Baidu has underperformed Alibaba and Tencent by a wide margin over the past three years, and that trend could continue for the foreseeable future. It's losing ground in China's advertising market, and its newer businesses are either unprofitable or failing to generate meaningful revenues. Those issues could persist, and that means Baidu needs to start answering some tough questions about its future.