Declining Online Marketing Revenue And AI Expenses Will Hurt Outlook

Key Takeaways

• Declining online marketing revenue and persistent challenges suggest a negative outlook for Baidu's advertising business.
  
• Aggressive AI and cloud investments may increase short-term costs, compressing net margins despite future potential.
  
• Baidu's AI-driven strategic initiatives in cloud services and ride-hailing are expected to enhance revenue growth, margin expansion, and market leadership.

Catalysts

Provides online marketing and non-marketing value added services through an internet platform in the People’s Republic of China.

• Baidu's online marketing revenue is declining and currently shows no signs of recovery due to persistent challenges and high sensitivity to macroeconomic conditions. This suggests a negative outlook for Baidu's revenue stream from its core advertising business.
  
• The aggressive investments in AI and cloud infrastructure, while promising, might lead to increased short-term costs without immediate equivalent returns. This could result in compressed net margins.
  
• The decision to open-source ERNIE 4.5 might drive adoption but could dilute the monetization potential of the technology as providing it for free reduces potential immediate revenue from licensing arrangements.
  
• Baidu's autonomous driving division, Apollo Go, is operating in an intensely competitive environment with a challenging ride-hailing price landscape in China. This could limit profitability and increase operational losses, further impacting earnings.
  
• The expectation of continued large expenses associated with expanding AI capabilities and AI-driven search reform might slow down improvements in operating efficiency, thereby negatively affecting operating income in the near term.

Baidu Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Baidu compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Baidu's revenue will grow by 2.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 19.0% today to 11.7% in 3 years time.
• The bearish analysts expect earnings to reach CN¥16.7 billion (and earnings per share of CN¥51.31) by about July 2028, down from CN¥25.4 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 13.4x on those 2028 earnings, up from 9.0x today. This future PE is lower than the current PE for the US Interactive Media and Services industry at 17.4x.
• Analysts expect the number of shares outstanding to decline by 1.61% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.84%, as per the Simply Wall St company report.

Baidu Future Earnings Per Share Growth

Risks

• Baidu's AI Cloud demonstrated robust momentum with accelerated revenue growth, which contributes positively to revenue and margin expansion.
  
• The investment in Gen-AI and the recognition of its market potential could drive further adoption across industries, potentially increasing Baidu's revenue and solidifying its technical leadership.
  
• ERNIE's widespread adoption due to its capabilities could lead to a steady increase in API demand, positively impacting revenue through greater market traction.
  
• Baidu's shift towards asset-light models in its autonomous ride-hailing service, Apollo Go, demonstrates strategic scaling and efficiency, which could enhance profitability and margin improvement.
  
• Baidu's strategic focus on AI transformation across its consumer-facing products and cloud services suggests potential revenue growth and increased user retention, ensuring sustained financial performance.

Valuation

• The assumed bearish price target for Baidu is $72.02, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Baidu's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $145.97, and the most bearish reporting a price target of just $72.02.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be CN¥143.0 billion, earnings will come to CN¥16.7 billion, and it would be trading on a PE ratio of 13.4x, assuming you use a discount rate of 9.8%.
• Given the current share price of $93.08, the bearish analyst price target of $72.02 is 29.3% lower.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.