Baidu’s [BIDU] share price plummeted after releasing first quarter 2019 earnings results, announced on 16 May, which painted a gloomy picture of how China’s slowing economy, and a government crackdown on online content, are taking a toll on one of the country’s biggest tech companies.
Online marketing revenues – the company’s bread and butter – grew by 3% year-on-year to $2.63bn, falling short of estimates set out by US financial data company FactSet. As a result, CEO Robin Li forecast a 3-2% drop to $3.74-$3.96bn in total revenues for the next quarter.Baidu 1-year share price performance, CMC Markets, 21 May 2019
“Although the Chinese government has announced many economic policies to bolster the economy, given the current macro conditions – tighter governments, excluding contents, cutbacks from the VC committee and so forth – we are taking a cautious view that online marketing in the near term will face a more challenging environment,” Li told shareholders during the earnings call.
The drop in revenue in its main online advertising business, which accounted for 73% of Baidu’s total quarterly revenue of $3.6bn, subsequently led it to post a net loss of $49m for the first time since floating on the Nasdaq in 2005.
Following the earnings announcement, Baidu’s share price tumbled a staggering 16% to below $130, erasing $8.9m off its market value and hitting a new six-year low. Shares have fallen 36% and 51% in the last six and 12 months respectively, attracting a slew of short sellers.
Share price decline in last 12 months
Almost 7 million shares were shorted at the beginning of May, in what has been the highest short interest in the company for more than a year. As trade tensions escalate between China and the US, the company is still in hot water.
“With the resignation of [senior vice president of the search business] Hailong Xiang ... and a $1bn share buyback programme initiated, together with softer-than-expected 2Q guidance, it seems like Baidu is facing multiple headwinds in addition to macro weakness,” Citigroup’s Alicia Yap, who lowered her price target from $262 to $205, wrote in a note to clients.
At least 14 analysts have cut their price targets on the stock since the earnings results were announced, with a further three downgrading from ‘buy’ to ‘hold’, according to Barron’s.
Is AI the key to diversifying revenues?
The company plans to fend off this bearish sentiment by expanding beyond its advertising business for revenue. While iQiyi – Baidu’s streaming service business that’s often described as the Netflix [NFLX] of China – made up the remaining $963m of revenue in Q1 and boasted a 58% year-over-year increase in subscribers on the platform, Li is placing his bets elsewhere.
Li’s “AI-first internet” strategy has seen the company increase the amount of artificial intelligence components in its products to better align services to consumer preferences and improve monetisation costs.
|PE ratio (TTM)||9.35|
Baidu share price vitals, Yahoo finance, 21 May 2019
“Notably, our AI-powered algorithms helped mail users on the Baidu platform find interesting content in the social commerce company's Smart Mini Program, increasing our user group that has been historically underrepresented.” The Baidu Smart Mini Program is an open-source system that allows external developers to build mini-programs for use on the Baidu platform.
“We are also working with the district of Beijing to develop an AI-powered city drain to improve municipal services. Our entrance into smart transportation is opening doors to the government market and potentially expanding into broader smart city solutions to help Chinese cities modernise.”
iQiyi is certainly another area of the business that will be getting an AI injection. Gong Yu, the CEO of the $14.2bn streaming business, said in a CNBC interview that the company would focus on incorporating AI and producing original content over the next two to three years. Such new services include Baidu’s news feed, short video app, voice assistant Duer and an autonomous driving unit (which, it is rumoured, may be spun out as a separate company altogether - although Baidu have since denied these reports).
iQiyi's market cap
However, the R&D spend on developing the algorithms and automation systems has had an effect on Baidu’s operating margin, which has fallen from 22% in Q1 2018 to just 4% in its latest quarter.
As the company looks to set a more solid foundation for growth, investors will be keenly watching to see if Baidu can beat the odds against it. One key metric to watch is Baidu’s 70% share of China’s online search market, particularly as incumbent rivals Alibaba [BABA] and Tencent [TCENY], alongside startups ByteDance and Douyin, all battle to take (or defend) their share of China’s 800 million internet users.