Baidu – Headache of state.

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Chinese regulatory risk laid bare in Baidu’s latest earnings report. 

• Baidu reported a difficult set of results where increasing government regulation of digital advertising has hammered its short-term growth.
• Q3 16A Revenues / Adj-EPS were RMB18.25bn / RMB9.92 compared to forecasts of RMB18.21 / RMB7.34 and RFM at RMB18.5bn / RMB7.86
• Headline revenues showed a decline for the first time but when Qunar (discontinued) is excluded revenue growth was 6.7% YoY.
• This is a far cry from its rivals Alibaba and Tencent who are running at 40%+ this year and even Google which is in the high teens.
• This is symptomatic of the crackdown by the Chinese government on digital advertising following the death of a cancer sufferer who used an experimental treatment that was found via a Baidu advertisement.
• In response to this incident, Baidu quickly put safeguards in place demanding much higher standards from its advertisers but the number of advertisers has declined by 15% and revenue growth has taken a big hit.
• In response to this decline, Baidu has had to reign in its marketing expenditure on Nuomi meaning that losses at the e-commerce platform were much lower than previously.
• This is what contributed to the better than expected profitability reported.
• However, as a result of lower marketing, GMV growth also slowed markedly calling into question the attractiveness of the platform for its 2.2m merchants going forward.
• This would be a good time for Alibaba to go on a charm offensive and persuade merchants to deal exclusively on Alibaba rather than using both.
• As a result of the new marketing regulations coming into force, Q4 16E guidance is weak with revenues of RMB17.8bn – RMB18.4bn well below consensus at RMB19.4bn and RFM at RMB20.6bn.
• While Baidu is struggling to get its core business back to growth, it is really talking up its advantage in artificial intelligence (AI).
• This is the right move to make as, like all search engines, it has an advantage in AI simply because it has been working on it for the greatest amount of time.
• Baidu intends to deploy this everywhere to make its services deeper, richer and more intuitive as well as powering autonomous driving and its digital assistant Duer.
• This could give it an edge over both Alibaba and Tencent and will certainly help it to keep Xiaomi, LeEco and Qihoo in the background.
• The bad news for Baidu has been largely priced into the shares which still look fairly attractive as there is a good chance that growth should pick up again once it has re-onboarded its advertisers under the new regime.
• Hence, Along with Tencent and Microsoft, it remains one of my top choices.