"Chinese companies are starting to dream," said early investor in Baidu (NASDAQ:BIDU) and managing partner at GGV Capital Jixun Foo. Foo's proclamation was made in an in-depth article by MIT Technology Review, which examined the Chinese search giant's new effort to change the world with artificial intelligence. The company's new AI lab does, indeed, accompany some lofty aspirations -- ones big enough to hopefully help Baidu become a global Internet powerhouse and to compete with the likes of Google in increasingly important emerging markets where the default search engine hasn't yet taken the throne.
But what are the implications for investors? Fortunately, Baidu's growing infatuation with AI looks like it could give birth to winning strategies that could build sustainable value over the long haul.
Finding an identity
Often referred to as the "Google of China," Baidu is known for unashamedly copying Google's winning tactics in China where it is the dominant search engine and where Google is banned. But as the company looks to emerging international markets, where Internet users are only up and coming, Baidu needs to begin finding its own identity. Baidu's AI push seems to fit the bill.
Baidu first announced its bigger plans for AI in May when it announced the hire of Google's Andrew Ng, who founded the rival search giant's Deep Learning team. Widely regarded as a leading figure in AI, Ng alone brings identity to Baidu. More importantly, his knowledge brings with him an opportunity for Baidu to play a leading role in AI.
Baidu's Silicon Valley AI lab has one "key quest," according to MIT Technology Review's Robert Hof: To create "software that can, in a real sense, learn on its own." In other words, Baidu wants to be the leader in deep learning. Deep learning, a new form of AI that attempts to build algorithms that reflect high-level human learning, is likely to play key roles in the future for companies with infinitely growing sums of data at their fingertips.
But Ng won't stop at deep learning. Heading up all Baidu research, Ng aims to help Baidu stand out in many aspects.
"It's Ng's job to develop cutting-edge technologies that will leave no doubt who is ahead," said Hof.
Ng's contributions over the coming years will likely be instrumental to Baidu's future. As Baidu expands internationally into markets where the company will go head-to-head with the likes of Google and Microsoft in vying for online search traffic, Ng could be the difference between new technologies that set Baidu ahead of competition. Further, the technologies Ng will work on are only those that could "significantly influence" the lives of at least 100 million people, he told MIT Technology Review -- ones that give a company a "lasting base to build on."
But is the cost justified?
Will the new strategies, tools, and platforms birthed from this AI research and development effort be worthy of the cost to acquire the required talent? Executives like Ng don't come cheap. And neither will the 70 AI researchers and computer systems engineers Ng wants to hire.
Baidu's second-quarter results demonstrated just how big of an effect ambitious R&D efforts are having on business results. Despite revenue growth of 58.5% from the year-ago quarter, net income growth trailed meaningfully behind at 34.1%. Unsurprisingly, soaring R&D costs were among the primary factors that weighed on profitability. R&D costs in Q2 were up 84.5% from the year-ago quarter.
Baidu said in its second-quarter earnings call that the main reason for the hike in R&D expenses was an increase in the number of R&D personnel.
Investors shouldn't expect R&D spending to level out in the near future. Going forward, Baidu said during the Q2 call that it will continue to invest aggressively in growth. While the company did say it plans to be disciplined in its expenses, building opportunities for near and long-term top line growth will continue to be the focus, management said.
But given the sustainability of online search as a lucrative business model, and the ample opportunity for growth in and outside of China as the global population of active Internet users continues to grow, long-term investors should be glad to see Baidu investing heavily in building the technologies that will support the company's future. Even more, an emphasis on deep learning specifically could help Baidu build an enduring edge in key areas while also carving out its own identity.