Baidu Q4: Why Earnings Missed Expectations

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Baidu Q4: Why Earnings Missed Expectations

MARKET INSIGHTS
mars 1, 2024

In its earnings release for Q4 and FY 2023, various line items in Baidu, Inc (BIDU) – ostensibly China’s answer to Google – has shown arguably the best performance in recent years. Despite this, the stock is said to have missed expectations resulting in the stock price dropping. Whether these expectations were high or not merit a closer look.

Trend Studies

Baidu can be considered to have four distinct main businesses:

« Core » which drives revenues much like Google Search does. « Core » also includes the Baidu App Store (much like Google Play) and Android-based smartphone operating system Yi.
« iQIYI » which is more like Netflix than YouTube.
« Apollo », a driverless vehicle endeavour much like Waymo.
« PaddlePaddle » (PArallel Distributed Deep LEarning) which, somewhat similar to Google Cloud’s Compute Engine, is an open-source deep learning framework released by Baidu in 2016.

Intuitively, it could be understood that « Core » is the traditional breadwinner for the company while the other divisions likely draw sustenance from and gain inroads on the back of the reach provided by the company’s dominant position in China’s fragmented search/marketing space. Trends in key line item trends for « Core » as a percentage of total line items juxtaposed with first-order trends (representing Year-on-Year or YoY changes) trends as well as second-order trends (representing « rate of change ») on total line item trends reveal an interesting picture:

Second-order terms are a mixed bag: there are very strong trends in swings for EBITDA, Free Cash Flow, et al in either direction, which suggests that passthroughs into earnings isn’t a simple proposition; there is substantial work in progress. In the present day, there are several indicators that the company’s non-Core businesses are improving:

While iQIYI’s average daily number of subscribers has witnessed a 6.7% YoY drop at 100.3 million, monthly average revenue per membership has witnessed a 12.8% YoY increase to RMB 15.98 (about $2.2)
As of the end of 2023, Apollo Go (Baidu’s autonomous ride-hailing service) has accumulated over 5 million rides, with fully driverless orders in Wuhan – a city of some world renown since 2020 – being nearly half of all orders.
PaddlePaddle now has 10.7 million developers that have deployed over 860,000 models for over 235,000 businesses.

As it stands, CEO and co-founder Robin Li states: « our commitment to Gen-AI and foundation models remains unwavering, paving the way for the gradual creation of a new growth engine. » In other words, Baidu won’t primarily be a search/marketing and subscriber content platform; it intends to be a primarily AI-relevant business in the future. If so, significant outlays towards building this next-generation business at the expense of core earnings can be expected to continue for several cycles more.

Performance Comparison: Stock vs ADS

Since the ADS represents a certain number of Chinese shares, it stands to reason that the US-listed ADS and the Chinese shares would be exactly similar, given that the two nations’ currencies as well as the « ADS Ratio » are effectively pegged. As it turns out, a significant difference in sentiment is apparent.

Source: Leverage Shares

Considering data from March 2022 till the 28th of February in 2024, US traded volumes have surpassed those in China on only 22 days; the latter tend to be anywhere from 10% to 706% greater than the former on any given day. Daily price performance upticks in the Chinese stock tend to be higher while downturns tend to lesser than that seen in the U.S. stock.

Despite the ADS effectively being derived from the Chinese share, the two aren’t necessarily fungible: effectively, one would have to separately dispose the ADS and buy the Chinese stock (if an investor was qualified by the Chinese government to do so). In fact, an increasing number of instituitional investors with the wherewithal to establish a commercial relationship within China’s jurisdiction have been switching to holding the Chinese stock over the ADS in greater proportions in instances where the company is « dual-listed ». In Baidu’s case, the benefit of this is clear: the ADS is at 63.4% of its value in March 2022 while the stock is at 71.98%.

Furthermore, the company repurchased $1.2 billion worth of stock from the public through 2020 and 2021. Given the trajectory of the stock in 2021, this ensured a 242% valuation premium to remaining shareholders who cumulatively received a $2.9 billion bump by the end of the year. In 2022, the company’s board announced a new share repurchase program with an upper limit of $5 billion, effective through 2025. As of 2023, the company has spent $669 million of this amount. However, given the stock trajectory, this only returned $318 million (or a 53% deficit) to shareholders.

Nonetheless, given that up to $4.7 billion is still on the table, this is the second benefit given to shareholders: there is a high likelihood of finding at least one « guaranteed » buyer for the stock: the company itself.

In Conclusion

Be it ADS or stock, there is a recalibration of sorts, as per the company’s messaging which seems to imply that it will soon be less « online marketing » (a mature business segment) and more « AI-relevant » (a business with substantial growth potential, many competitors and unknown regulatory hurdles). It’s important for investors to be attuned to what they’re buying into: the present or the future. If the present, passthrough earnings will likely remain impacted as the company grows towards its desired future. If the latter, there are many hurdles to overcome.

In the present, the stock is likely overvalued; in the future, the stock might turn out to be cheap right now. What bridges the present and the future is the depth of investor conviction in the company’s leadership being able to do this transition.

Footnotes:

« Baidu Announces ADS to Share Ratio Change », Baidu Investor Relation, 28 April 2010
« Has this ratio ever changed? If so, when and how? », Baidu Investor FAQs accessed as of 29 February 2024

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Préparé par

Sandeep Rao

mars 1, 2024