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Baidu & the Bad News Bears

By Rick Munarriz - Jun 14, 2016 at 9:05AM

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The leading Chinese search engine warns that it will fall well short of its earlier guidance.

Image source: Baidu.   

The other shoe has fallen at Baidu (BIDU -0.38%). China's leading search engine hosed down its revenue guidance for the current quarter following yesterday's close.

Baidu now expects to generate between $2.807 billion and $2.823 billion in revenue for the current quarter that ends later this month. Its earlier outlook was calling for $3.119 billion to $3.192 billion on the top line. It's a pretty dramatic revision. 

Baidu generated $2.673 billion in revenue a year earlier, so the tweaked outlook calls for just 5% to 6% in year-over-year growth. Its earlier guidance would've resulted in as much as 19% top-line growth. A weakening yuan relative to the dollar over the past year and the de-consolidation of its online travel business may be sandbagging results, but even after backing those factors out we're talking about growth in the mid-teens. It's a far cry from the 31% adjusted top-line growth that Baidu reported during the first quarter, at the time its worst quarter of growth as a publicly traded company. That will change.

Health scare

There's a good reason for the revision. A Chinese university student died in late April after seeking cancer treatment from a questionable medical center that he found as a keyword advertiser on Baidu's search engine. Baidu came under fire after the story went viral, and Chinese regulators began to investigate.

Can a search engine be held accountable for the quality of its advertisers? It's a gray area, but in China this isn't the first time that a search platform has come under fire for the qualifications of a sponsor. Regulatory agencies concluded that Baidu shouldn't base the positioning of medical-related ads on merely the highest bidder, an important distinction given the lucrative nature of keywords when it comes to health categories. The sponsor's reputation would be a factor, making it easier for low bids to make it to the first page of search results.

The agencies also requested that healthcare ads make up less than a third of the ads on a query results page and that Baidu make the distinctions clearer between paid and organic search results. Baidu agreed to the regulatory suggestions in early May, and at that time we knew that its earlier forecast was no longer valid. 

The revision was going to be substantial. Analysts figured that as much as 30% of its paid search business is the handiwork of medical and pharmaceutical advertisers. The last time that Baidu came under fire for playing loose with healthcare sponsors -- in late 2008 -- it revealed that 10% to 15% of its revenue was at stake. Lowering its outlook by just 10% may come as a relief, until you realize that the changes at Baidu didn't kick in until we're more than a third of the way into the quarter. 

Timely downgrade

Citi analyst Alicia Yap pushed out a fortuitous update, downgrading shares of Baidu on Monday morning. She based the move -- lowering Citi's rating from Buy to Neutral and slashing her price target from $238 to $180 -- on concerns that it would not be able to meet its earlier guidance. It was impeccable timing, as Baidu hosed down its guidance just a few hours later. 

Baidu stock will naturally take a hit today, but if the carnage is contained it's because a lot of the bad news is already baked into the stock. Baidu shares have surrendered 16% of their value since the cancer treatment center story broke. Investors have every right to be skittish. This summer's quarterly report will be huge, especially as we get a better read on what Baidu is forgoing as it modifies its paid search practices. The news is bad. Baidu better make sure that it doesn't get worse.

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