Baidu: Earnings Beat With A Chinese ChatGPT Catalyst
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$Baidu(BIDU)$ (NASDAQ:BIDU) is often referred to as the "Google of China" and was ranked as the Number 1 AI Cloud provider, in H1 '22accordingto an IDC study, cited by Baidu. The company also aims to launch aChatGPT equivalent called "Ernie" very soon and is poised to benefit from AI market growth trends. The AI industry was valued at ~$93 billion in 2021 and isforecastto grow at a rapid 26.5% compounded annual growth rate [CAGR], reaching a value of just under $27 billion by 2026. Baidu has recently reported solid financial results for Q4 '22 as it beat both top and bottom line growth estimates. In addition, the company has announced a humongous buybackprogramof up to $5 billion up until 2025. This would significantly reduce the number of shares outstandingand thus ultimately boost the stock price over time. In this post, I'm going to break down the company's financials, before diving into its trends around AI, self-driving vehicles and reveal my valuation model for BIDU stock. Let's dive in.
Data by YCharts
Solid Financials
Baidu reported solidfinancial resultsfor the fourth quarter of 2022. Its revenue was $4.8 billion (RMB 33.1 billion) which beat analyst forecasts by $172 million, despite being down ~8% year over year or flat on a constant currency basis. Breaking it down by segment, Baidu core reported $3.72 billion in revenue (RMB 25.7 billion), down 1% year over year. Similar to Alphabet (GOOG) (GOOGL) or Google in the west, Baidu generates the majority of its revenue from its online advertising business, which contributed to ~59% or $2.84 billion of revenue in Q4 '22, down ~5.4% year over year. This is not too bad given we are currently experiencing a cyclical downturn in the advertising market. In addition, CV19 had a resurgence in certain cities in China, which didn't help bolster consumer demand. A positive is advertising spend tends to be cyclical by nature with a tightening during uncertainty or recessionary periods, followed by a major spend splurge during the "good times".
Revenue (Baidu)
There is also a positive with regards to CV19; as sourcesindicate, China's health agency is close to downgrading the virus from a Class A to Class C which would put it in a similar category to influenza or seasonal flu. "Violent" protests across many Chinese cities have also acted as a catalyst for the easing of restrictions. Therefore, I expect consumer mood, and thus demand, to improve which should be a positive for Baidu and its advertising customers.
Ironically, Baidu has actually benefited in some part from the CV19 rebound as health-related search queries increased by 40% year over year.
Baidu total app monthly active users [MAUs] were 648 million, which increased by 4% year over year.
The company also utilised its resources to create a CV19 index based upon real-time search queries. This is valuable information as if many people search for CV19 symptoms in a certain area, that can act as a leading indicator of a virus rebound. Baidu provided this information to public health authorities and hospitals, which really is an essential service.
The ChatGPT of China
In the words of Microsoft CEO Satya Nadella, AI is at an "inflection point" after the viral platform ChatGPT became the fastestgrowingapplication of all time!
However, due to the "great firewall of China," the application has been blocked and OpenAI didn't make the original application available in the country. However, unlike many other western applications which are blocked in China, the Chinesegovernmentis even cracking down on users accessing it via a VPN. This is because the Chinese Communist Party has raised concerns about the bot's ability to spread "false information" which of course is a controversial subject, especially when it comes to asking ChatGPT questions related to alleged human rights breaches in certain countries.
Either way, the ban opens a door for Baidu to release a similar chatbot, which it has dubbed "Ernie". Baidu has many years of experience in the AI industry and has the vast infrastructure (via its Cloud business) to support such an application. On its Q4 '22 earnings call, management announced plans to "fully integrate" the Ernie Bot across all of its operations. This will first include Baidu search, which I imagine will be similar to the integration Microsoft has offered with its Bing search engine. The company also has plans to integrate it within its Xiaodu smart speaker, which is similar to Alexa. I believe this could be a major game-changer as you can effectively speak directly to and even have conversations with the AI.
Baidu also aims to offer the service as a platform, similar to the GPT-3 AI, which will enable developers and its business customers to build more products on top of it.
Self-Driving Vehicles on the Road
Many companies talk a lot about "self-driving" vehicles and companies such as Waymo (by Alphabet/Google) are running pilot tests in San Francisco and Arizona. However, Baidu feels ahead in terms of running a commercial operation. In Q4 '22, its ride-hailing service (Apollo Go) provided 561,000 rides, which increased by a blistering 162% year over year. Its total rides provided to the public surpassed 2 million by the end of January 2023.
The company also received Beijing's first license to test autonomous vehicles, which paves the way for its service to hit the roads in the capital.
Cloud Continues to Grow
Baidu has continued to grow its cloud business with its "AI Cloud" growing by 4% year over year. As mentioned in the introduction, the IDC ranks Baidu cloud as the number one cloud provider, despite otherforecastsindicating the company is fourth by market share. Therefore, the IDC study could indicate the company is the number one "AI cloud" provider. Either way, the company is poised to benefit from the growth in China's cloud industry which is forecast to nearly triple from the $32 billion valuation in 2021 to $90 billion by 2025, according to a McKinseystudy. Its cloud developer community has also continued to scale to a staggering 5.32 million developers and over 200,000 businesses.
The Netflix of China (iQIYI)
Baidu also reported steady growth in its video streaming service $iQiyi Inc.(IQ)$ , which generated revenue of $1.1 billion, up 3% year over year. While its total subscriber numbers increased from 97 million in Q4 '21 to 111.6 million in Q4 '22. A positive of any lockdowns in China, is Baidu's video service will likely benefit from increased engagement, similar to the trend we saw with Netflix during 2020.
Margins and Balance Sheet
Moving onto profitability, Baidu reported earnings per share [EPS] of $1.97, which beat analyst forecasts by $0.65. This was a positive since and given by improved operating leverage as Baidu's cost of revenue declined by 2% year over year and its SG&A expenses declined by 9% year over year. Therefore, the company is in a much leaner position than the prior year, while still achieving similar revenue which is a positive sign.
Baidu has a fortress balance sheet with $26.87 billion in cash, cash equivalents and short-term investments. The company does have fairly high total debt of $13.4 billion but the majority of this (over $9.1 billion) is long-term debt and thus manageable.
Valuation and Forecasts
In order to value Baidu, I have plugged its latest financial data into my discounted cash flow valuation model. I have forecast 6% revenue for "next year" or 2023. This is based upon an improving CV19 situation and improving economic conditions in China. This is backed by IMF economicforecastswhich expect 5.2% GDP growth for China in 2023, which is great considering most countries are expecting negative to flat growth. In years 2 to 5, I have forecast 11% revenue growth per year, as I forecast advertising revenue rebound as consumer demand comes back. I also expect continued growth in Baidu's Cloud business, its chatbot AI (when launched) and its self-driving vehicles.
Baidu stock valuation 2 (Created by author Deep Tech Insights)
To increase the accuracy of my valuation model, I have capitalized R&D which has boosted net income. I have forecast a pre-tax operating margin of 24% over the next 7 years. This is 1% higher than the software industry average and I believe is achievable given the scale of the company and its improving operating leverage which was discussed prior.
Baidu stock valuation 2 (Created by author Deep Tech Insights)
Given these factors, I get a fair value of $249.79 per share. The stock is trading at ~$142 per share at the time of writing, and thus is over 43% undervalued intrinsically and relative to historic multiples.
As an extra datapoint, Baidu trades at a forward price to sales [P/S] ratio = 2.5, which is 27% cheaper than its 5-year average. This is also substantially cheaper than Alphabet or Google in the west, which trades at a P/S ratio = 4.
Data by YCharts
Recession/China Political Risk
Many parts of the world (including the US) areforecastto enter a recession in 2023. This will likely have an impact on China given the country generates a large portion of its GDP from exports. Then, of course, we have the political risk in China which can involve "big tech" regulation, fines and even delisting from US exchanges. These risks are all part of any investment into China and are partially the reason why many Chinese stocks trade at lower valuation multiples than the west.
Final Thoughts
Baidu is tremendous technology company which has strong leadership position in search, and has continued to expand across multiple areas from AI, to the Cloud and even autonomous driving. I love that Baidu actually executes and doesn't just forward sell "moonshots" like many other companies in the west. Its stock is undervalued intrinsically according to my model and forecasts, and thus it could be a great long-term investment.
Source: Seeking Alpha
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